Cryp­tocur­ren­cies pose tough new ques­tions for au­di­tors, reg­u­la­tors


How do you value some­thing that only ex­ists vir­tu­ally? What if that some­thing is a cryp­tocur­rency — vir­tual money that is not backed by any gov­ern­ment or cen­tral bank, or any­thing in the phys­i­cal world?

The lack of good an­swers to these ques­tions has brought un­cer­tainty to the fi­nan­cial world over cryp­tocur­ren­cies, the most well known of which is Bit­coin. While cryp­tocur­ren­cies are de­signed to op­er­ate peer-to-peer, with­out a cen­tral­ized repos­i­tory or reg­is­ter, this un­cer­tainty is caus­ing cryp­tocur­rency star­tups to rein­vent the very in­ter­me­di­aries, cus­to­di­ans, au­di­tors and book­keep­ers that the cre­ator of Bit­coin was so ea­ger to do away with.

Over the past four years, cryp­tocur­rency in­ter­me­di­aries have op­er­ated as trusted third par­ties, in­creas­ing their chances of reg­u­la­tory scru­tiny and over­sight, says Baker McKen­zie as­so­ciate Maksym Hlo­tov.

But the fi­nancier points out that there are no uni­fied poli­cies for them to fol­low — and that’s a prob­lem.

“Cryp­tocur­ren­cies can’t be ac­tu­ally called a cur­rency for many rea­sons,” Hlo­tov says. “In fact, peo­ple don’t know how at all to in­ter­pret them. Are they se­cu­ri­ties? De­riv­a­tives? Or are they a com­mod­ity? There’s no po­si­tion on that.”

And be­cause of this un­cer­tainty, the fi­nancier says, com­pa­nies that deal in cryp­tocur­ren­cies don’t know how to present their vir­tual as­sets in their fi­nan­cial re­ports.

“To­day ev­ery­thing de­pends on in­di­vid­ual po­si­tions — the cre­ativ­ity or con­ser­vatism of a lawyer or a CEO of a par­tic­u­lar com­pany,” Hlo­tov told the Kyiv Post. He said cryp­tocur­ren­cies have cre­ated “a new economy” that to­day ex­ists “par­al­lel to the con­ven­tional one.”

“And yet tra­di­tional ac­count­ing tools are not fully adapted to work in this so-called ‘economy 2.0,’” Hlo­tov said. “Only when there are more prece­dents will the fis­cal author­i­ties and law­mak­ers be able to pro­vide more clar­i­fi­ca­tions.”

An ex­am­ple of an economy 2.0 process that is lack­ing in reg­u­la­tion is an ini­tial coin of­fer­ing, or ICO, which is now be­ing used as an al­ter­na­tive way to tra­di­tional ini­tial pub­lic of­fer­ings (IPOs) to raise cap­i­tal.

ICOs can be de­fined as an un­reg­u­lated means of crowd­fund­ing via the use of cryp­tocur­rency. For a busi­ness that works with cryp­tocur­rency, it as an al­ter­na­tive to the reg­u­lated cap­i­tal-rais­ing process used by ven­ture cap­i­tal­ists, banks, or stock ex­changes.

ICOs are ba­si­cally a mar­ket sale of a com­pany’s to­kens (the equiv­a­lent of shares in an IPO) that can in fact be any­thing, in­clud­ing the ac­tual shares of a com­pany, but which can be bought only with a cryp­tocur­rency.

Au­dit­ing and ac­count­ing mar­ket play­ers say the lack of fi­nan­cial reg­u­la­tion is a sig­nif­i­cant draw­back of ICOs, and with­out in­ter­na­tional agree­ment on con­duct­ing ICOs, coun­tries are tak­ing mat­ters in their own hands. China, for ex­am­ple, re­cently banned this kind of fundrais­ing on its ter­ri­tory, brand­ing it a form of pyra­mid scheme.

Mykola Tsyrkun, a se­nior au­dit man­ager at KPMG in Ukri­ane, says part of the prob­lem is that peo­ple don’t re­ally know what they’re buy­ing in an ICO.

“Tra­di­tion­ally I buy shares. What do I buy in an ICO?” asked Tsyrkun. “What does a startup sell? What do its to­kens mean?”

But Volodymyr Panchenko, the CEO of DMar­ket, a Ukrainian tech com­pany that pre­vi­ously used an ICO to raise $11 mil­lion, and which is get­ting ready for its next ICO in Novem­ber, sees no prob­lem with the fi­nan­cial re­port­ing and ac­count­ing for this way of rais­ing cap­i­tal.

“Com­ply­ing with all pro­ce­dures and le­gal re­quire­ments and hav­ing the le­gal opin­ion of lo­cal lawyers on hand, au­dits are not a prob­lem at all,” Panchenko told the Kyiv Post.

Panchenko’s com­pany con­ducted prepa­ra­tions for its first ICO in ac­cor­dance with the reg­u­la­tions of the United States, which DMar­ket sees as its tar­get mar­ket.

There, the com­pany uses the ser­vices of two law firms: one spe­cial­iz­ing in tax­a­tion, and the other in dig­i­tal cur­ren­cies.

Abid­ing by the leg­is­la­tion of the coun­try in which one works or plans to work al­lows a com­pany to come up with a dig­i­tal iden­ti­fi­ca­tion of all ICO in­vestors, even if they used a cryp­tocur­rency, in which trans­ac­tions can be en­tirely anony­mous, to make their in­vest­ment, said Panchenko.

Panchenko agreed with Tsyrkun though — be­fore a com­pany sells its to­kens it must first ex­plain the eco­nomic prospects of these to­kens — their value, and the ex­pected change in their value.

But he said if all such plan­ning is prop­erly done, a clas­si­cal ven­ture fund can in­vest into com­pany that has un­der­gone an ICO and be­come a part­ner any time.

Baker McKen­zie’s Hlo­tov said Panchenko’s ap­proach might be ex­actly the one to take for sake of ease of au­dit­ing and trans­par­ent fi­nan­cial re­port­ing.

Ac­cord­ing to Hlo­tov, in some ju­ris­dic­tions na­tional reg­u­la­tors have al­ready looked at the ICO phe­nom­e­non and drawn up reg­u­la­tory poli­cies. Au­dit com­pa­nies that check a com­pany with as­sets in cryp­tocur­rency in these coun­tries will thus have guid­ance on how to as­sess the value of its vir­tual as­sets.

In coun­tries where na­tional reg­u­la­tors have not drawn up reg­u­la­tory poli­cies, such as Ukraine, most likely au­di­tors will re­fer to some prece­dents on the mar­ket or fol­low prac­tices used in other states.

“Ev­ery­thing will be for­mal­ized very soon in coun­tries that have ac­tive reg­u­la­tors,” Hlo­tov said.

“While in coun­tries with in­ac­tive reg­u­la­tors, like Ukraine, there will just be mar­ket stan­dards.”

The Kyiv Post’s IT cov­er­age is spon­sored by Cik­lum. The con­tent is in­de­pen­dent of the donors.

A trader runs across the floor at the clos­ing bell of the Dow In­dus­trial Av­er­age at the New York Stock Ex­change on Aug. 23 in New York. Rel­a­tively new and cur­rently hot ini­tal coin of­fer­ings, or ICOs, are now be­ing used as an al­ter­na­tive to tra­di­tional...

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