Blog: Business and cryptocurrencies – future or failure?
Jamie Watt looks at the business risks associated with cryptocurrency projects, and the potential for it to be a gamechanger.
The concept of exchanging items of value for trade or payment has been with us for thousands of years. Evidence has been found dating back to 7000BC. Sumerian cuneiform tablets, detailing sheep and goat assets, dating from 2000BC, exist.
Payment means have evolved through the ages, through commodity (precious metals) based money and fiduciary money (asset-backed paper money), and fiat currency (government-backed currency), to where we are now.
Some say cryptocurrencies are just the natural evolution of our payment system. More than 1,100 cryptocurrencies now exist, with a market capitalisation over $150 billion.
But what are some of the risks, and is it worthwhile for business to now look at cryptocurrency based projects?
Regulation of cryptocurrencies
Regulation is key to business and cryptocurrencies are already regulated. Those issuing coins in relation to their projects in the UK would need to consider the nature of the coin and the applicable legal regime. This regime already exists. At the very least coins may be considered electronic money, however, in some cases they are likely to fall within the remit of legislation relating to shares and their offering to the public. In both cases, the impact of the FCA regime, along with primary laws, would need to be evaluated and addressed.
Cryptocurrencies are currently essentially useless in relation to the purchase of traditional goods and services. Exchanges, transferring coin into fiat currency, are key. An exchange operating in respect of Europe would be subject to the various laws relating to anti-money laundering, enacted pursuant to the 4th Money Laundering Directive, along with other pertinent regulation, such as the GDPR and laws relating to the prevention of tax evasion.
Similarly, businesses dealing in cryptocurrency based in the EU would need to consider these.
Some say cryptocurrencies are a great enabler, a force for freedom and good. However, they have been used for nefarious purposes and a real risk exists that, per Gresham’s Law, the bad money will drive out the good out of the market.
Legal issues in respect of cryptocurrencies are by their nature multi-jurisdictional. One of the beauties of cryprocurrencies is the ease with which they allow interaction with persons abroad. This is also one of their significant weaknesses, from a legal point of view.
In engaging in cryprocurrency projects, business is likely to have to consider laws not just relating to the UK and the EU, but further afield. Projects often bring with them, particularly, a need to consider some of the complexities of US law, given the strength of certain states in tech. US securities law, for example, are a particular concern for initial coin offering (ICO) projects. US commentators mention the Howey Test, which addresses the investment of money with an expectation of profits from a common enterprise depending solely on the efforts of others. The Japanese regulators have already declared Bitcoin a payment instrument for regulatory purposes.
Trust is key to the cryptocurrency system. In relation to ICO projects particularly, it is the case that you would be placing your trust, and your funds, effectively in the hands of others, dependent on their effort and success. There are already significant concerns over the ability to conduct appropriate due diligence, and to understand the specific business risks, in projects operating around a coin sale. White papers are often not detailed; some ICOs have shown to be exercises in fraud, with no comeback; and other ICOs have been admitted to be a joke that got out of hand (look at Dogecoin, for example).
Along with legal issues come some significant practical issues.
In dealing in, and issuing, coins on the blockchain, one is working in a highly volatile and undependable marketplace, automatically placing projects in the high-risk category. Some countries have banned the operation of exchanges. Some exchanges have recently stopped allowing holders to exit Bitcoin into fiat currency. Some exchanges and wallet providers have been hacked. Wallets held on physical equipment can be lost if the equipment is stolen.
One of the key properties of money is that it is an effective store of value, and one must question whether cryptocurrencies adequately fulfil this. The same goes for another key property of money, that it can be exchanged for things which are useful. Few businesses accept Bitcoin. One must question whether this property is properly fulfilled at this point in time.
Tax is another risk. Dealing in or with cryptocurrencies brings with it the possibility of gains. Paying people in coins creates income, and potentially payroll obligations. On death, cryptocurrencies pass as part of the deceased’s estate, as inheritance. All of these situations have tax consequences. And you can’t pay tax with cryptocurrencies.
In the US, the IRS have subpoenaed Coinbase to acquire user trading information. The same may happen with other exchanges. One of the wonderful aspects of cryptocurrencies is that they sit on the blockchain; and this means audit trails. And alongside the tax risk, there is also exchange rate risk to factor in.
Technology and mobility – biggest change since the internet?
However, cryptocurrencies are, at present, highly mobile. One can effectively seek to transfer “value” instantaneously, and across borders, simply, where the recipient has internet access. Given the growth in mobile communications, particularly in the developing world, this can offer a solution for market entry where other means for receiving payment may not exist.
The technology underlying cryptocurrencies, the blockchain, is also massively important.
In essence, using decentralised ledger technologies, a fraud protected, “proof of work” system is enabled. This creates significant advancements in data dependability, security, and as such data commercialisation. With concurrent advancements in data gathering, with this enabled reliability, automation of business processes is also made much more viable.
Couple this with advances in artificial intelligence and machine learning, and one can perhaps entertain the thought that we are in the early stages of the most significant innovative change in technology since the advent of the internet. Business ignores this at its peril.
- Jamie Watt is a partner at Harper Macleod