Wednesday, September 13, 2017

Bitcoin clampdown: Towards a corporate-cryptocurrency?

WSJ reported that the Chinese government was working to shut down Bitcoin exchanges:

"China’s central bank together with other regulators has drafted instructions banning Chinese platforms from providing virtual-currency trading services, according to people familiar with the matter...regulators told at least one of the exchanges that the decision to shutter them has been made, one of the people said. Another said the order may take several months to implement."
China, however, is not the only has such issues with crypto currency. The US also has limited the use of Bitcoin by taxing it as a capital gain:

"Capital-gains tax rules could make using bitcoin as a currency a logistical nightmare. It meant that when U.S. citizens filed taxes, they had to account for every single bitcoin acquired, sold, or used for purchases, and the prices and dates at which those transactions happened. If you purchased 0.5 bitcoins at $360 in April 2014 and sold them for $645 on June 9, you’d have to declare that gain as a taxable event in 2015. Fair enough. But did you have to account for swings in the value if you used your bitcoin to purchase a vacation on Expedia or to order a pizza? The IRS’s move seemed to undermine bitcoin’s potential for use as a currency." Vigna, Paul. The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order (p. 260). St. Martin's Press. Kindle Edition. 

However, the key regulatory action against Bitcoin came from the FDIC and DOJ:

"bitcoiners would report that agents from the Federal Deposit Insurance Corporation, the body charged with cleaning up failed banks so that insured depositors can be kept whole, were pressuring bank compliance officers not to work with bitcoiners. It’s hard to verify this claim. The FDIC had long communicated its concerns to bankers over supposedly high-risk categories of merchants, and bitcoin businesses were told by bank compliance officers they were included in those groups...

The U.S. Department of Justice, too, sent banks messages that contradicted FinCEN’s accommodating message. In 2013, the DOJ launched an initiative known as Operation Choke Point, in which it investigated banks dealing with merchants in businesses that weren’t necessarily illegal but were considered high fraud risks. Miami-based lawyer Andrew Ittleman, who has become something of an accidental expert on the subject, told us that Operation Choke Point now occupied most of his time and that primarily his clients were legal providers of bitcoin services and medical marijuana, along with a few pornographers and gun dealers. The law was having a chilling effect: banks might not be breaking the law by servicing such businesses, but the risk of an audit from the DOJ was enough to dissuade them from doing so. Ittleman fought hard for his clients, who were denied a vital instrument of financial access, but it was an uphill battle. The matter, he said, should be taken up to the Supreme Court by civil rights activists such as the American Civil Liberties Union." (ibid p. 258-259)

Why are governments so worried about Bitcoin?

The WSJ article cited above gives a clue:

"Beijing’s crackdown on bitcoin is part of a broader effort to root out risks to the country’s financial system. Officials earlier this year circulated a draft of anti-money-laundering rules for bitcoin exchanges, a powerful warning, even though the regulations were never formalized, according to people familiar with the matter...Virtual currencies in theory allow holders to bypass China’s traditional banking system to move money outside its capital-controlled borders. That could make it more difficult for Chinese regulators to maintain a tight grip on the yuan." [Emphasis added]

Cryptocurrency has its roots in the anarchist activists and others who saw Bitcoin as a way to challenge the power of banking sector. Given that Bitcoin had its debut during the Financial Crisis, it may have been reasonable to believe that there would be sufficient groundswell to believe that the cryptocurrency would gain popularity.

However, popularity in the realm of currency and capital is not sufficient to change institutional realities of societies. 

The reality of societies today is that financial institutions, and corporations more broadly, represent institutions that keep the society together. Since they hold the keys of the society, ultimately they will control the change that will proliferate through society. And something that undermines the ability of the society's today to control capital flows is pretty much a national security issue - and can expect a response that reflects that reality. In other words, it was reasonable to expect the Empire to Strike Back as they did. 

Can we ever expect a corporate-sponsored cryptocurrency? 

Given the way power works, the only one that can really challenge banks hegemony are other corporations. For example, Walmart teams up with generic drug makers (in competition with expensive brand-name alternatives) to reduce the healthcare benefits they pay to their employees.

On requirement would be to have direct access to customers so they can actually convert their cash into that digital currency. For example, online realtors are dependent on banks and their electronic payment networks to essentially get cash into the system. 

So likely a retailer alliance could be something that poses a challenge to banks and their networks. 

Amazon already has Amazon Coin, but I think that if they teamed up with Walmart you would have something that basically has wide acceptance. And that's when the games will begin.

Retailers also have an incentive to cut-out the banks and save those credit card fees. However, for this to have user acceptance the retailers would need to give their consumers a cut. 

But would this be a true cryptocurrency? 

Such a currency would likely take a permissioned or private blockchain route. Essentially, there will be a need for 'independent verifiers' (instead of miners) that will ensure that the transactions are properly accounted for. This is likely cheaper than using miners which are costly in terms of the energy costs that have to be paid

Although I think external auditors could play the role of the independent verifier, these systems can be highly automated and an assurance model can be developed where you have real-time assurance as the source documents would be digital. This is assuming that the cryptographic keys can be relied on for such a purpose and auditors are able to get "effortless" access to such evidence and systems. So it may lead to a renaissance in the audit but may help auditors realize their potential within the field of audit data analytics and more broadly as data scientists. 

This speaks to one of the key aspects of automated audits that I raised on this post. As promised, my plan is to delve deeper on this topic, where we can look at how blockchain can facilitate AI or automated audits. 

Ultimately, banks play a critical role in extending credit which essentially makes them gatekeepers of the consumer economy. However, other companies, largely the tech sector, are hoarding cash:

Courtesy of Business Insider

So the question is whether these non-banks could move into bank territory. For example, Rogers Wireless (cell phone provider) is also a bank. That being said, it likely won't be a revolution but could be something that evolves over time that steadily erodes bank power. However, that would mean that the banks would take this lying down and I don't think that the Empire will go out without a fight.

Author: Malik Datardina, CPA, CA, CISA. Malik works at Auvenir as a GRC Strategist that is working to transform the way we do financial audits. The opinions expressed here do not necessarily represent UWCISA, UW, Auvenir, Deloitte's or anyone else.

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