China’s Bitcoin Ban: A boon for Canada or are we waiting for the bubble to burst?

China’s continued clampdown on bitcoin has provided an impetus for miners to relocate to USA and Canada. In this article, Forbes noted that China’s, National Development Reform Commission (NRDC) might identify bitcoin mining as an activity that is causing harm to the environment. The article also cited that problem of the ability for the rich to evade the country’s capital controls, which I raised in this post. The NRDC has put May 7th as the deadline when it will ban bitcoin. As a result, Bitmain Technologies is looking to relocate in Canada (and the US) and BTC.Top is “opening facilities in Canada.”

Will this relocation to Canada prove to be a boon or is it a prelude to the inevitable bursting of the Bitcoin bubble?

The valuation for cryptocurrencies and crypto-assets ultimately depends on the underlying asset that backs the digital token held by management. That is, certain crypto-assets represent a service or delivery of future assets. For example, State of Wyoming has “ cleared a bill that would exempt certain types of crypto assets from securities laws…so-called “utility tokens” that are “exchangeable for goods and services.” For such tokens, valuations specialists would be needed to understand the underlying value of the service or goods to assess the value.

Cryptocurrencies, on the other hand, are highly volatile. Some companies use the spot price to determine their value and report it on their financial statements. Hive Blockchain notes on financial statements that:

“Digital currencies consist of cryptocurrency denominated assets (Note 8) and are included in current assets. Digital currencies are carried at their fair value determined by the spot rate based on the hourly volume weighted average from www.cryptocompare.com. The digital currency market is still a new market and is highly volatile; historical prices are not necessarily indicative of future value; a significant change in the market prices for digital currencies would have a significant impact on the Company’s earnings and financial position”.

With that in mind, it is essential to remember that the onset of any innovation is accompanied with an investment bubble and cryptocurrencies are no exception. For example, during the DotCom Bubble, 457 companies had an initial public opinion in the final year of the boom. According to Wired, “[m]any of the most promising companies filed for bankruptcy including Pets.com, WorldCom and FreeInternet.com.” This is the reality of how investment has worked within Capitalist economics. We see a similar pattern in the British Railway Mania of the 1840s, where “[p]rices of railway shares rose by an average of 106% between 1843 and 1845, but the market then crashed, and during a prolonged decline, railway shares fell back below their original value”. With the Dot Com Bubble, Wired article notes that:

“While this boom and crash was unfortunate for investors, it actually produced some of the most innovative ideas that were simply just ahead of their time. Concepts developed by many companies that went under, including VoIP, eCommerce, big data and the web experience, still live on today, in many cases as the fundamental concepts driving success in large corporations.”

The railway investment mania led to the development of railways in the UK. The other innovation? Accounting. According to an academic paper published by Professor Andrew M. Odlyzko:

“The 1840s were a period of dramatic growth and change for British accountants. Many of today’s big accounting firms trace some of their roots to that period. As just one example, the accounting firms around the world that use the name “Deloitte” derive it from William Welch Deloitte, who set up his own practice in London in 1845. There is rare unanimity among experts on this period in attributing the growth in the ranks and prosperity of accountants to the rising demand for accounting services from the railway industry.”

When applying these lesson to crypto-currencies (that use the proof-of-work algorithm), the reality is that there is no underlying asset or service – other than a digital token that cannot be double spent. Therefore, unlike the Dot Com companies – who could at least feign a business model – cryptocurrencies have no mechanism of delivering value to its holders or purchasers. Consequently, the best way to mitigate against valuation shocks is to avoid investing in such speculative investments.

Author: Malik Datardina, CPA, CA, CISA. Malik works at Auvenir as a GRC Strategist that is working to transform the engagement experience for accounting firms and their clients. The opinions expressed here do not necessarily represent UWCISA, UW, Auvenir (or its affiliates), CPA Canada or anyone else.