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.

Blockchain: What is a 51% Attack?

Earlier this month, Ethereum Classic suffered a 51% attack.

Although it was not the first cryptocurrency to get attacked, it did have the moniker of one of the big brand names of the crypto-world. That being said, Ethereum Classic is not the main branch of the Ethereum but rather the branch who decided not to go with the decision of the foundation to undo the damage caused by the DAO Hack.

Everything gets hacked, so what makes such an attack so special?

When promoting the bitcoin blockchain, many blockchainthusiasts have touted its tamper-resistance properties as something that users can hang their hats on. Don Tapscott, as one example, notes that since the bitcoin is"transparent, peer-to-peer, and administered by everyone who uses it, it's all but impossible to corrupt"; implying that such an attack is not something that a bitcoin user should worry about.

So what is exactly a 51% attack?

As noted in my process flow post, the idea here is that the segregation of duties concept is breached because the miner has effectively the ability to write to the ledger on their own.

Did a few searches but Ivan Liljeqvist does the best job in terms of breaking it down:

In summary, the hacker will use their hashing power to build a “secret” chain that is longer than the active chain that contains the transactions submitted by the attacker. This secret chain will not contain those transactions. Then at the right time, the attacker will publish their secret chain. Since it is the longer chain (i.e. as the attacker has 51% of the hashing power), it will be accepted by the protocol and displace the public chain, thereby allowing the attacker to spend those bitcoins again, as the official record (which has now propagated across the network) does not record those transactions as spent but as retained by the attacker.

The key to his explanation is the following:

• The longest chain principle: the network essentially is able to maintain integrity as long as 51% of the hashing power is distributed as it is only the network that is capable of generating this chain; not a single person. The bitcoin blockchain protocol uses this control to resolve to the situation where two chains are being created simultaneously. For example, let's says miner in Canada has identified the nonce for a block of transactions. However, a miner in Japan has also arrived at a nonce for the same block of transactions. Which chain should take precedence? The protocol will declare the longest chain the winner, where length is a function of the difficulty to create that chain. Therefore, as long as the majority of the hashing power is distributed across the network, the control will function as intended. 
• Specific transactions will be compromised: The attack allows to double spend on their transactions or transactions they are paid to attack. The rest of the records on the blockchain are not impacted by the attack.
• The attacker can win each competition: What's interesting is whether the attacker would bother double spending their transactions when they can simply win each mining competition. 

That being said, the system will lose trust if such attacks became rampant. If that were to happen, miners have the most to lose if such a thing. were to occur. 

The bottom line is that all blockchain is like any piece of technology. The bitcoin blockchain network, which has numerous miners is very different than a newer blockchain that is unproven. Consequently, we can't simply assume because something is a blockchain it will be "auto-magically" invincible. 

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