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Transacting in Crypto-Assets: Management Considerations and Controls for Small and Medium-Sized Enterprises Ii Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises ii DISCLAIMER This publication was prepared by the Chartered Professional Accountants of Canada (CPA Canada) as non-authoritative guidance. CPA Canada and the authors do not accept any responsibility or liability that might occur directly or indirectly as a consequence of the use, application or reliance on this material. © 2019 Chartered Professional Accountants of Canada All rights reserved. This publication is protected by copyright and written permission is required to reproduce, store in a retrieval system or transmit in any form or by any means (electronic, mechanical, photocopying, recording, or otherwise). For information regarding permission, please contact [email protected] Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises iii Table of Contents Preface 1 State of Crypto-assets 3 The Crypto-bubble 3 Are all Crypto-assets Equal? 4 Evolution of Bitcoin as an Alternative Payment Method 5 Crypto-assets in Hand: What Now? 6 Business Considerations Related to Crypto-assets 7 For Transactional Purposes 8 For Investment Purposes 9 Internal Control Considerations Related to Crypto-assets 10 Internal Controls and Security 10 Auditor Expectations 13 Regulatory Environment 15 In Canada 16 Internationally 16 Appendix I: Analysis of Crypto-asset Hacks 18 Appendix II: Ten Questions to Ask When Considering Crypto-assets for Your Small and Medium-sized Enterprises 23 Appendix III: Select Regulatory Guidance 24 Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises 1 Preface Have you heard of Bitcoin? At its peak, one bitcoin was valued at approximately US$20,089.1 Bitcoin is an example of a crypto-asset. Crypto-assets rely on blockchain technology to enable individuals and businesses to transact directly with each other without an inter- mediary such as a bank or other fnancial institution. If your business is thinking of using or accepting crypto-assets as a form of payment, this publication will provide an overview of crypto-assets used as a medium of exchange and highlight some important business considerations and controls for your business. By the end of 2018, the previous hype around crypto-assets had declined signifcantly, but some businesses are still investing in and transacting with crypto-assets. However, many industry professionals supporting small and medium-sized enterprises may have little or no experience with crypto-assets and therefore may not fully appreciate the risks associ- ated with crypto-asset transactions. With US$1.7 billion of crypto-assets stolen in 2018 alone,2 it is paramount that businesses implement strong security practices to prevent theft of crypto-assets from their organizations. Businesses also need to be aware that crypto-assets are not backed by government fat and should be considered a highly speculative asset class. Unlike the tech companies that went bankrupt in the early 2000s with the collapse of the tech bubble, crypto-assets have no mechanism for delivering tangible value to their holders or purchasers. Consequently, businesses should be aware of this reality before engaging with crypto-assets. This non-authoritative publication is intended to provide industry professionals in small and medium-sized enterprises with guidance on some of the top crypto-asset issues organiza- tions that are transacting with crypto-assets are facing today: • determining the business strategy as it relates to crypto-assets • internal control considerations when engaging in crypto-asset activities • navigating the regulatory environment for crypto-assets. This publication is part of a broader set of CPA Canada resources related to crypto-assets. To learn about possible approaches to accounting for crypto-assets under IFRS®, refer to An Introduction to Accounting for Cryptocurrencies. For guidance under ASPE, refer to An Introduction to Accounting for Cryptocurrencies under ASPE. As to the implications 1 According to coinmarketcap.com, high price of US$20,089 for bitcoin was reached on December 17, 2017. 2 www.reuters.com/article/us-crypto-currency-crime/cryptocurrency-thefts-scams-hit-1-7-billion-in-2018-report -idUSKCN1PN1SQ Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises PREFACE 2 of crypto-assets for the fnancial statement audit, refer to Audit Considerations Related to Cryptocurrency Assets and Transactions. To learn more about the underlying blockchain technology, refer to An Introduction to Blockchain Technology. About the Authors CPA Canada would like to express its gratitude to Malik Datardina of Auvenir and Michael Wong of CPA Canada, who authored this publication. CPA Canada would also like to express its gratitude to the members of CPA Canada’s Technology Advisory Committee for their contributions to this publication. Comments Please contact us with any feedback or insights that could help in the development of future publications on this topic. Michael Wong, CPA, CA Davinder Valeri, CPA, CA Principal Director Research, Guidance and Support Research, Guidance and Support CPA Canada CPA Canada 277 Wellington Street West 277 Wellington Street West Toronto ON M5V 3H2 Toronto ON M5V 3H2 Email: [email protected] Email: [email protected] Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises 3 State of Crypto-assets Five hundred million stolen overnight. The crypto-asset exchange Coincheck was hacked in January 2018 for a loss of 500 million NEM coins3 worth about $500 million.4 One of the main security lapses identifed was that the exchange kept the customers’ assets in what is known as a hot wallet and did not implement multi-signature security. This event, along with a multitude of other hacks and security breaches, highlights the importance for busi- nesses of having strong controls for managing crypto-assets and related transactions. A hot wallet is connected to external networks while a cold wallet is not. A multi- signature wallet is one that implements multi-signature security and requires multiple sign-ofs before a transaction is processed. Further details on the types of wallets and when they should be used is discussed in the “Internal Control Considerations Related to Crypto-assets” section below. For the purposes of this publication, we use the term crypto-assets to mean only those crypto-assets used as a medium of exchange and intended to act as an alternative to government-issued fat currencies. For example, Bitcoin would be considered such a crypto-asset while smart contracts that do not primarily function as a general-purpose medium of exchange would not. The Crypto-bubble The value and popularity of crypto-assets have grown exponentially in recent years. The market capitalization of crypto-assets increased from US$18 billion on December 31, 2016, to US$613 billion on December 31, 2017, an astonishing increase of 3,406%5 that created news headlines such as “KFC Canada starts accepting Bitcoin for a bucket of chicken, immediately sells out”6 and “Burger King Launches Crypto-asset ‘Whoppercoin’ in Russia”7. 3 NEM coin is a crypto-asset supporting the NEM blockchain and was launched on March 31, 2015. 4 http://fortune.com/2018/01/31/coincheck-hack-how 5 https://coinmarketcap.com/charts 6 https://business.fnancialpost.com/news/retail-marketing/no-joke-kfc-canada-starts-accepting-bitcoin-for-a-bucket-of -chicken-immediately-sells-out 7 http://fortune.com/2017/08/25/burger-king-russia-cryptocurrency-whoppercoin Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises STATE OF CRYPTO-ASSETS 4 GOOGLE SEARCHES FOR “CRYPTO-ASSETS” SINCE 2013 INTEREST RELATIVE SEARCH TIME Source: Google Trends The popularity of “crypto-assets” surged in 2017 as evidenced by the spike in Google search interest during that period. The vertical axis represents search interest relative to the highest point on the chart since 2013. A value of 100 is the peak popularity for the term. A value of 50 means the term is half as popular. The market capitalization of crypto-assets peaked at approximately US$829 billion in January 2018 and was followed by a drastic decline as the market capitalization of crypto-assets fell by approximately US$698 billion or 84% to US$131 billion by the end of December 2018.8 Are All Crypto-assets Equal? There are currently over 2,100 diferent crypto-assets9 and the number continues to grow as it is relatively easy to create a crypto-asset. Although at a high level, many crypto-assets share similar characteristics (e.g., decentralization and built-in security), they should not all be treated the same. Not surprisingly, a ftting analogy would be to compare a basket of crypto-assets to a basket of fat currencies. Within the universe of crypto-assets, some like Bitcoin are widely used like the USD, and many others are treated like emerging market cur- rencies and have lower popularity and higher risk. 8 https://coinmarketcap.com/charts 9 https://coinmarketcap.com/all/views/all as at January 16, 2019. Transacting in Crypto-assets: Management Considerations and Controls for Small and Medium-sized Enterprises STATE OF CRYPTO-ASSETS 5 The most popular crypto-assets are Bitcoin and Ethereum. Bitcoin was designed as a digi- tal payment system. Ethereum is similar but layers on smart contract capabilities and is sometimes used as a funding mechanism through a process known as an Initial Coin Ofer- ing (ICO). However, this publication focuses on crypto-assets that are used as a method of payment and store of value. Top 10 Crypto-assets by Market Cap $100,000.00 $90,000.00 $80,000.00 $70,000.00 $60,000.00 $50,000.00 $40,000.00 US$ MILLIONSUS$ $30,000.00 $20,000.00 $10,000.00 $0.00 Bitcoin Ethereum XRP Bitcoin EOS Litecoin Binance Tether Stellar Cardano Cash Coin Source: coinmarketcap.com as at April 18, 2019 Evolution of Bitcoin as an Alternative Payment Method Before the recent hype around crypto-assets and bitcoin, the ability to purchase goods with bitcoin was a novelty.
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