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...