CRYPTOCURRENCIES This paper gives only the barest outline, a very brief account and offers some conclusions. Established currencies (e.g. US dollars, pounds sterling etc) are backed by a government authority (the Fed, the Bank of England) which controls the supply of the currency. These currencies are termed “fiat currencies”, to distinguish them from cryptocurrencies. Cryptocurrencies (or digital currencies or virtual currencies) are a modern innovation. Bitcoins are the best known and so far the most widely used crypto-currency. Like fiat currencies, a cryptocurrency is capable of being used for three purposes: (a) A store of value (b) A means of exchange/payment (c) A unit of account. MEANS OF PAYMENT Fiat currency Although fiat currencies have tangible manifestations (coins and notes), they are also digital. A given owner, A, will usually have his/her holding represented purely digitally, i.e. by a number in A’s bank account. When A makes a payment (e.g. of £40) to B other than by paying cash, the net result is a reduction of £40 in A’s holding in his bank account and a corresponding increase in B’s holding in B’s bank account. Where A’s and B’s accounts are in different banks, the payment mechanism involves each of those banks and also one or more intermediaries (e.g. a bank clearing house) in making debits/credits in their accounts. The costs in operating such systems are borne, directly or indirectly, by the account holders. Crypto-currency A (properly set up) cryptocurrency will have a publicly available ledger comprising a single blockchain. The ledger identifies every place where a digital currency is held using letters and numbers (the wallet address). The identity of the owner/user of any wallet remains private whilst she/he transacts solely in the cryptocurrency but such anonymity evaporates when the user interacts with a fiat currency. Any given transaction ( e.g. C pays 2 bitcoins to D) does not pass through any intermediary but is included (as a blockchain or part of a blockchain), directly by C in the ledger which is viewable by all. The transaction can be, and will be, validated by those users of the currency who conduct “mining” activity. “Miners” (validators) will be rewarded by a small amount of currency for each successful validation of a blockchain. This particular mining process is called Proof of Work; other processes such as Proof of Stake are also capable of verifying transactions in this way. There may be some delay before any given transaction is validated. Once it is validated, a blockchain (and a transaction it represents) is an immutable part of the ledger. The reward is given to the successful miner; it is given by the particular cryptocurrency system and according to its rules (protocols); that reward can be seen as the cost of operating the payment system.
Publicly available ledger: The ledger of a cryptocurrency is not to be found in a bank account, or a clearing house account.
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It is
distributed across the myriad computers of those who use the currency and is viewable by all of them. It is held on a public website and can be viewed by anyone with an internet connection. This publicly viewable ledger is known as a blockchain and is viewable via a blockchain explorer. The founders of a cryptocurrency will usually create the first blockchain explorer for their cryptocurrency but any independent body can also create a blockchain explorer. Most cryptocurrencies have multiple independent blockchain explorers all based on the same public data.
Protocols: The protocols (or rules) which govern a crypto-currency are created by those who first establish the currency (the founders). In a Proof of State system the protocols are capable of being changed only with the consent of the majority (by value) of those holding the currency. In a Proof of Work system (e.g. Bitcoin), they can be changed only with the consent of miners holding the majority of mining power (i.e. irrespective of the amount of currency held by those miners). The protocols will normally include rules governing how many coins can be released (created) each year and also governing the maximum number of coins which will ever be released. Thus, for example, there is a finite number of Bitcoins which can be released and it is likely that, unless the protocol is changed, the total amount of Bitcoins will have been released by 2040. The method by which coins are released is by making them available (as mentioned above) to “miners” in return for the miners successfully validating the blockchain (i.e. transactions).
Source code: In addition to the blockchain, the founders of a (properly established) cryptocurrency will also release every line of code that governs the software that they have created. This public code is also held on an open website for anyone to see. This code allows third parties to verify the claims of the founders about the total number of coins that will be created and other aspects of their innovation.
Exchanges: An exchange is where a cryptocurrency can be exchanged for a fiat currency – and vice versa. Anyone can set up an exchange. An exchange is thus not necessarily controlled by the persons who are founders of the virtual currency. Most cryptocurrencies are traded on multiple digital currency exchanges, the overwhelming majority of which are not run by the founder of the coin. In addition, a live coin, will have a daily traded volume. This volume and trading on multiple independent exchanges defines the fiat currency value of a cryptocurrency. A cryptocurrency that is not publicly traded has no publicly verifiable value.
E-Wallets: A wallet is where an owner of cryptocoins can store them. It holds the private keys associated with the particular individual owner. Wallets can be provided (e.g. by supply of an app) by anyone and are (usually) independent of the founder of the cryptocurrency, though the founder will usually supply the first “core” wallet. Coins which lack multiple blockchain explorers, an open, publicly available source code and are not traded on multiple independent exchanges have the following deficiencies: 1. It cannot be proved that the coin exists. 2. There is no way to verify the transactions that are made with the coin. The same coin can be spent infinite times without a public blockchain. 3. The ledger essentially consists of a private spreadsheet, which can be adjusted and changed at will by whoever holds the file. 4. The total supply of the coin can be changed at will by whoever holds the private file. -2-
5. The claimed value of the coin cannot be tested in an open traded market, and thus the coin has no public value. This is akin to the difference between actually owning a hotel on Park Lane and owning that hotel during a game of Monopoly.
Public lists There are a number of websites that list cryptocurrencies. While not rigorous, these websites indicate (on their coin request forms) some basic information that any cryptocurrency should be able to provide, such as a public blockchain and source code, in order to get listed. Examples of these sites are:
https://www.worldcoinindex.com/ http://coinmarketcap.com/currencies/views/market-cap-by-total-supply/ https://www.coingecko.com/en?sort_by=market_cap
UK TAX TREATMENT OF CRYPTOCURRENCIES This is set out in HMRC Guidance (Brief 9) issued on 3 March 2014. In essence:
VAT is not payable on transactions conducted in bitcoins or a similar currency, other than being incorporated in the fiat-currency price which the bitcoin payment represents. Income tax is payable by someone who receives bitcoins (or similar) as remuneration for work. Capital Gains Tax is payable on gains made on the sale of bitcoins (or similar). There are no special Corporation Tax rules relating to cryptocurrencies. Profits and losses arising from a company’s transactions involving bitcoins (or similar) will be reflected in the company’s accounts and taxable under the normal rules.
RISKS As with any innovation, cryptocurrencies have attendant risks. It appears to be generally accepted that a blockchain is a very secure way of transmitting money (or other data). The publicly available and widely distributed nature of the ledger means that it is virtually impossible for someone to gain control over it or to corrupt it. The European Banking Authority, in its Opinion (EBA/Op/2014/08) lists a very wide range of risks under the following headings:
Risks to users Risks to non-user market participants. Risks to financial integrity. Risks to payment systems and payment service providers in Fiat Currencies. Risks to regulatory authorities.
It lists risks as in one of three categories: High; Medium; Low. Risks to users which are indicated as being “High” include, amongst others, the following:
Risks associated with exchanges: An exchange can be operated by anyone and exchanges are unregulated: risks include that the exchange acts fraudulently or collapses financially. There is no deposit protection scheme.
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Risks associated with e-wallets: An e-wallet may be provided by anyone (e.g. by the supply of an app); they can malfunction, be hacked and be the subject of theft - and there is no deposit protection scheme. Also passwords can be lost or forgotten and there may be no system for re-issuing or re-setting passwords.
Risks associated with the cryptocurrency scheme itself: The protocol governing a cryptocurrency is not subject to any independent standards and changes can be made following a decision by those having a majority of the scheme’s mining power (in a Proof of Work system) or a majority by value of those holding the currency (in a Proof of State system) and those changes can introduce errors. RELATIONSHIP OF CRYPTOCURRENCY WITH MLM These is no particular relationship between these two, any more than there is a relationship between fiat currencies and MLM operations. There is a risk that somehow someone will one day seek to combine the two in a malevolent way. In 2015 and 2016 warnings were issued in a number of European countries about one particular currency1. Whereas MLM direct selling companies market a wide range of products, from cosmetics to food supplements to household goods, It would be extremely worrying, for example, if an MLM operator were to sell cryptocurrency as products which the company markets. It would be not be a good idea to provide a direct seller with an incentive to make sales of a cryptocurrency, even if that were possible. It would be like direct selling US Dollars or British Pounds. A company could market physical hardware products such as mining computers designed to mine cryptocurrencies, but that is different from selling the cryptocurrency itself. On the other hand, there seems nothing wrong with offering items (amounts) of cryptocurrency as rewards/payments to direct sellers under the terms of the company’s 1
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Direct Selling Association of Norway: http://www.direktesalgsforbundet.no/vil-ikke-vaere-politi/ Financial Supervision Commission of Bulgaria: http://www.fsc.bg/en/news/annoncement-onecoin-8108.html Austria’s Federal Ministry of Labour: https://stmk.arbeiterkammer.at/beratung/konsumentenschutz/achtung_falle/onecoin_betrug sverdacht.html Latvia’s Financial and Capital Market Commission: http://www.fktk.lv/lv/klientu-aizsardziba/bridinajumi-par-nelicencetiem/5659-fktkbridina-par-onecoin-sniegtajiem-pakalpojumiem.html The Swedish Gaming Board: http://www.gp.se/nyheter/g%C3%B6teborg/polisen-utreder-onecoin-1.6048 Belgium’s Financial Services and Markets Authority: http://www.fsma.be/en/Site/Repository/press/warnfsma/2016/07-08_onecoins.aspx Bank of Hungary: http://www.mnb.hu/felugyelet/felugyeleti-keretrendszer/felugyeleti-hirek/hirekujdonsagok/sajtokozlemeny-ujabb-kockazatok-a-fizetesre-hasznalhato-virtualis-eszkozokkoreben
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compensation plan. Of course, if this done, what is being offered as a reward (e.g. bitcoins and not a fiat currency) must be made very clear to the direct sellers. Ideally also, the uncertain value of the currency (e.g. because of volatility in its price against fiat currencies) should also be spelt out. One would expect that what might be termed “basic commission” is payable in a fiat currency and that any payment of it in a cryptocurrency would be optional – even if higher awards were offered only in a cryptocurrency. CONCLUSIONS FOR THE DSA 1. There is nothing inherently bad about cryptocurrencies. Bitcoin is well established as are some others. Ideally there should be legal regulation, as strongly urged by the EBA Opinion mentioned. 2. It seems likely that regulation of (at least some aspects of) cryptocurrencies will come about sooner or (more probably) later - possibly only after there has been some sort of disaster or crisis (possibly of a type as yet unforeseen). 3. In its quarterly bulletin number 3 in 2014, the Bank of England published two papers on: (i) Innovations in Payment Technologies and the Emergence of Digital Currencies, and (ii) The Economics of Digital Currencies. It concluded that digital currencies do not serve a substantial role as money in society and that it is unlikely that, as currently designed, any digital currency will emerge as the predominant money in an economy. 4. Sophisticated financial products, e.g. derivatives, based on a cryptocurrency, should be viewed with extreme caution. 5. A hall-mark of a good cryptocurrency must be that its protocols and its ledger are publicly available to all and available from sources independent from the founder. A cryptocurrency lacking this feature should be avoided. 6. Users of a cryptocurrency would be well advised to be cautious about which ewallets they use and which exchanges they use. 7. A direct selling company should not be selling a cryptocurrency amongst the products which it markets. There is, however, no objection in principle to the giving of bitcoins (or similar) as awards/commissions under a marketing plan (or as a reward to a party hostess).
Paper written by, Code Administrator of the Direct Selling Association of the UK. 13 Sept 2016.
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