Opinion
Cryptocurrency by Henry Duggan, Andrew Pimlott and Madhur Mishra

Cryptocurrency
by Henry Duggan, Andrew Pimlott and Madhur Mishra

The concept of cryptocurrency has attracted widespread attention in recent years. At the simplest level, a cryptocurrency is essentially a digital currency which utilises advanced cryptography to facilitate anonymity and security in transactions. Cryptocurrencies can therefore be viewed as forms of digital money which can be used to purchase goods and services. Examples of such cryptocurrencies are Bitcoin, Ethereum, Ripple and Cardano.

Cryptocurrency trading can be conducted by both retail traders (individual investors) as well as institutional traders (large organisations such as hedge funds). Because of the volatility and potential for high returns, cryptocurrency trading can be inherently risky. As such, traders should be well-informed and cautious when conducting such trades. It’s also important to utilise a reliable and reputable cryptocurrency exchange. Some exchanges are more appropriate for beginner traders, while others are designed for those with significant experience of conducting such trading activity.

This article will provide an insight to the basic underlying technology associated with cryptocurrencies, along with a synopsis of the key highlights in their development, advantages and risks, regulatory environment and financial reporting requirements.

The Blockchain

Most, but not all crypto currencies are established in Blockchain technology, which is in essence a decentralized, distributed public ledger which exists across a network. The Blockchain is essentially a repository, a place to digitally store information, usually transactional. This store of information is called the Block.

These blocks are not stored in one central database but are instead spread-out across various connected computer systems. The reason that the data is very difficult to corrupt is because the same database is stored across different computer networks called nodes.

So, for example, imagine a database containing records of 100 transactions. All the nodes supporting the blockchain will have an identical copy of the database. The correct version of the database is therefore always assumed to be the version that is consistent across the majority of the nodes.

Therefore, if someone wishes to make an unauthorised change by deleting a transaction on one node, there will not be any impact to the overall database because the majority of the databases across the network will still show 100 transactions and the unauthorised change will be disregarded. Given the prevalence and increased media attention on cryptocurrencies in recent years, it is useful to consider some of the key highlights in the evolution of such digital currencies.

1983: American Cryptographer David Chaum conceived an anonymous cryptographic electronic money system called ecash1.

1989: Digicash launched as an electronic money corporation, allowing for anonymous transactions due to the implementation of cryptographic protocols2.

1999: PayPal electronic payments system launched3.

2008: “Bitcoin: A Peer-to-Peer Electronic Cash System” published by Satoshi Nakamoto4.

2009: Bitcoin network came into existence with the mining of the Genesis block on 3 January5.

2014: Tokyo-based Mt. Gox — once the world’s biggest Bitcoin exchange — suspended all trading and went offline in February 2014 after losing about 850,000 Bitcoin valued at about $500 million at the time6.

2014: OneCoin was founded by Ruja Ignatova and Karl Sebastian Greenwood. In December 2002, Greenwood pled guilty in Manhattan federal court to wire fraud and money laundering charges in connection with his participation in a massive OneCoin fraud scheme, which marketed and sold a fraudulent cryptocurrency by the same name through a global multi-level-marketing (“MLM”) network7.

2021: Beeple Artwork “Everyday: The first 5000 days” sells attached to an NFT for $69 million8.

2022: Terra Luna crash occurred in June, which had a follow on impact on the entire cryptocurrency market (estimated $300 billion loss)9.

Pros and Cons of Cryptocurrency
There are a number of significant advantages to the concept of Cryptocurrency.

  • Security
    It is very difficult to attack a blockchain. All transactions are encoded using complex cryptography that is impossible to break using today’s global computing power.
  • Transferability
    Cryptocurrency facilitates transactions with parties on the other side of the planet as seamless as paying with cash at a local grocery store.
  • Privacy
    While all transactions recorded on the blockchain are public, the identity of the person carrying out the transaction is private and need not be disclosed.
  • Transparency
    Every transaction on the blockchain is published publicly, without exception. This means there’s no room for manipulation of transactions.

Similarly, there are also a number of disadvantages such as:

  • Cyber Security Issues
    There has also been an increased propensity for the holders of digital wallets (these store an individual’s passwords or private keys to access their cryptocurrencies) to experience hacking and cybersecurity breaches10.
  • Inconsistent Regulation
    The regulation of cryptocurrency varies significantly across multiple jurisdictions. Financial regulation within the context of the Irish Financial Services market falls within the remit of the Central Bank of Ireland. However, there have been no regulations issued specifically to address cryptocurrencies, save to the extent that such regulation is addressed by activities covered by other legislation. For example, the issuance of the Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Bill 2020 provided the foundations for the 5th Anti-Money Laundering Directive in Ireland. In essence this bill moved to amend the existing Criminal Justice (Money Laundering and Terrorist Financing) Act 2010 to give effect to Directive (EU) 2018/843 of the European Parliament and of the Council of 30th May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and amending Directives 2009/138/EC and 2013/36/ EU. In March 2021, the Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021 was effected which stipulated that Virtual Asset Currency Providers (cryptocurrency) are required to comply with the same AML requirements already imposed on financial institutions, and conduct appropriate due diligence on clients. Notwithstanding this lack of specific regulation, the Central Bank of Ireland has issued numerous warnings relating to cryptocurrency. For example:
    • In April 2021, the Central Bank of Ireland warned about the risks of buying or investing in virtual currencies, virtual assets and cryptocurrencies11. It was stressed that virtual currencies such as Bitcoin and Ether were unregulated and that while such currencies can be used as a means of payment, they do not have legal tender status, and are not guaranteed or regulated by the Central Bank of Ireland, or any other central bank in the EU. Furthermore, some of the risks highlighted previously in this paper (such as volatility) were also emphasised.
    • In March 2022, a warning was issued highlighting risks of investing in crypto assets, as part of a European-wide campaign by the European Supervisory Authorities12. The speculative and risky nature of such assets was highlighted alongside a message that such investments may not be suitable for retail customers. Derville Rowland, the Central Bank’s Director of General Financial Conduct stated that: “In Ireland and across the EU we are seeing increasing levels of advertising and aggressive promotion of crypto asset investments. While people may be attracted to these investments by the high returns advertised, the reality is that they carry significant risk. Before you buy crypto assets, you need to think about whether you can afford to lose all the money you invest. Do the promised fast or high returns seem too good to be true? “People should also be aware that if things go wrong, you do not have the protections you would have if you invested in a regulated product.”
man sitting at table looking at laptop
Money Laundering/Sanctions Evasion and Fraud Concerns
Cryptocurrencies have also been seen to form part of international sanctions evasion networks. For example, in September 2021, it was announced that Virgil Griffith, a U.S. citizen, pleaded guilty to conspiring to violate the International Emergency Economic Powers Act (“IEEPA”) by providing services to the Democratic People’s Republic of Korea, including providing technical advice on using cryptocurrency and blockchain technology to evade sanctions13.

Fraud is a risk in any financial market, and the cryptocurrency market is no exception. Because crypto markets are relatively new and not as heavily regulated as other financial markets, they may be especially vulnerable to fraud. There are a few different types of fraud that are commonly seen in the crypto markets, including:

  • Ponzi schemes: As highlighted by the US Securities and Exchange Commission, these are investment schemes in which returns are paid to existing investors from funds contributed by new investors, rather than from any actual profit earned14.
  • Pump-and-dump schemes: These are schemes in which a group of individuals artificially inflate the price of a particular cryptocurrency by buying it in large quantities and then promoting it heavily on social media. Once the price has been artificially inflated, the individuals behind the scheme sell their holdings, leaving other investors with worthless assets.
  • Exit scams: Exit scams are when fraudulent projects or ICOs simply disappear with the money that investors have invested.
  • Phishing scams: These are schemes in which individuals attempt to steal personal information, such as login credentials or private keys, by pretending to be a legitimate exchange or service.

It’s important to keep in mind that not all cryptocurrencies and blockchain projects are at risk of fraud, but it’s always important to conduct sufficient research and due diligence before investing in any cryptocurrency or blockchain project.

Financial Reporting

Similar to the regulatory environment highlighted previously, there is no specific guidance related directly to accounting for Cryptocurrency holdings. In June 2019, the IFRS Foundation Interpretations Committee published an agenda decision which concluded that IAS 2 “Inventories” applies to cryptocurrencies when they are held for sale in the ordinary course of business. If IAS 2 is not applicable, then an entity should apply IAS 38 to such holdings15.

Conclusion

It is important to remember that cryptocurrency is still a relatively new technology, so such markets can be quite volatile with a high level of uncertainty. Despite the significant attention attracted by cryptocurrencies across multiple jurisdictions, they retain a number of significant risks for investors, both retail and institutional. The prices of cryptocurrencies can be highly volatile and are influenced by a wide range of factors, including regulatory developments, economic conditions, and market sentiment.

It is therefore difficult to predict with certainty what will happen with the crypto markets in 2023. Whilst some believe that the crypto markets may re-bound from their slump in 2022, others believe that there could be further adverse fluctuations in the future years. Additionally, cryptocurrency still faces numerous regulatory challenges, and any negative regulatory developments could have a major impact on crypto markets.

Henry Duggan
Henry Duggan
Andrew Pimlott
Andrew Pimlott

Senior Managing Director

Madhur Mishra
Madhur Mishra

Senior Director at Ankura