Australian Digital Currency Commerce Association

ACAMS PRESENTATION 30 September 2014

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Agenda

1. What is Bitcoin?

2. How are Bitcoins Used?

3. The Growing Digital Currency Industry

4. Taxing Digital Currencies

5. Bitcoin as a Payment System

6. AML/CTF issues

7. Accounting Control

8. Q & A

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What is Bitcoin ?

What is Bitcoin?

Video

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What is Bitcoin ?

Bitcoin is a protocol that enables the transfer of value between two people.

Bitcoin is a unit of value that is transferred between to people using the Bitcoin protocol.

Bitcoin is denominated in Satoshis 100,000,000

Push based paradigm, rather than pull

• A Protocol (like http, or tcp, or torrent, or any other set of rules which governs how something operates). • Store of value - literally a number - like the number 5 on a AUD$5 note. (It’s people who own them that assign them real world

value, not unlike USD since detaching from gold in 1933). • Like dollars are broken into cents, Bitcoin can be broken down into 8 decimal points (colloquially, ‘Satoshis’).

• What is Bitcoin ?

It’s like traditional currency

• Fully Traceable

• Fully Auditable

What is Bitcoin ?

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What does Bitcoin look like?

This is a Bitcoin address, a seemingly random jumble of letters and numbers. How Bitcoins are mostly interacted with. A QR code representation of the address (this is a donation to the IAPF address)

What is Bitcoin ?

• Anyone can see the transaction on the Blockchain (a public, transparent ledger).

• This example is from the site blockchain.info a publically available website that can traverse the Blockchain.

What is Bitcoin ?

Mining Reward for each mathematical block solved in the block chain. The reward will reduce based a predetermined formula, cutting in half about every four years, once every 210,000 blocks - max 21 million bitcoins in circulation

What is Bitcoin ?

Where do you keep a Bitcoin address?

• Bitcoin addresses (and therefore Bitcoins) are kept in a ‘wallet’ • The wallet is in your control and responsibility and has your Bitcoins in it • This is an example of a Bitcoin wallet on android

What is Bitcoin ?

Private Keys

A private key is a secret code which allows the user to prove his ownership of his Bitcoins. Every Bitcoin address has a matching private key, which is saved in the wallet file of the person who owns the balance. The private key is mathematically related to the Bitcoin address, and is designed so that the Bitcoin address can be calculated from the private key, but importantly, the same cannot be done in reverse.

What is Bitcoin ?

What Does a transaction actually look like?

So lets look at an example: • IAPF – International Anti Poaching Foundation accepting Bitcoin as a donation.

What is Bitcoin ?

• Coins get sent from one address to another. • Hit the Bitcoin network • One miner grabs the transaction and puts it with a bunch of others on the chain

What is Bitcoin ?

The donor then scans the QR code with their phone, and in a few seconds the payment is

received

What happens is the donors Bitcoin wallet contacts the Bitcoin network and signals that it wants to Authorise transfer value from the current address to the one scanned in

What is Bitcoin ?

What is Bitcoin ?

At this stage the payment has been received by recipient

• The recipient then receives and is in control of the coins sent. • Payment processor can convert BTA to AUD/FIAT

How Bitcoins Are Used?

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Bitcoin businesses

1. Bitcoin miners (e.g. Digital CC)

2. Exchanges (e.g. Bit Trade Australia)

3. ATMs (e.g. ABA Technology)

4. Wallets (e.g. Xapo)

5. Payment Processors (e.g. BitPOS)

6. Financial Services (e.g. Coin Arch)

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Examples of bitcoins used commercially

1 Paying for services • Pay Mel B, former Spice Girl. • Pay your lawyer or other consultant. • Pay for space travel on Virgin Galactic.

2 Paying for goods • Buy a Lamborghini or Tesla car. • Pay for a coffee or buy a beer in Sydney. • Buy flights or book a hotel through Expedia.

3 Global Micropayments • Send money to relatives (e.g. in the Philippines) and avoid 9% remittance fees.

• Trade with businesses in other jurisdictions for small transactions without attracting large bank fees.

• Donate to charities across the globe and avoid 10% processing fees.

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Bitcoin adoption rates

Current market capitalisation is over $8 billion USD.

60,000 online retailers globally already accept Bitcoin.

Expedia has joined the likes of Overstock, Square and Dell in accepting Bitcoins.

PayPal announcement that they have partnered with BitPay, Coinbase, and GoCoin to

integrate bitcoin payments into the PayPal Payments Hub.

Growth from 40 businesses to 250 businesses in Australia between January to June

2014.

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Bitcoin drives financial inclusion

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Source: World Bank

Case Study: Philippines

Credit card penetration is less than 5%.

Less than 30% of Filipinos have a bank account.

In 2010 Filipino expats sent $21.3 billion back into the PI.

Average fees for these transactions was 9%.

To use Bitcoin, all that is needed is a mobile phone.

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The Growing Digital Currency Industry

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Nearly 13 million bitcoins currently in circulation

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December 2013 – Bitcoin overtook Western Union

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Current market cap is $8.1 billion USD

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Bitcoin investment

Global investment in FinTech hit $3 billion in 2013. Set to reach $8 billion by 2018.

Over $300 million USD invested into bitcoin ventures in the past 18 months, with

$200 million in 2014 alone (Winklevoss twins).

Bitpay raised USD$30m in series A funding from investors that included Richard

Branson.

Nearly $11 million has already been invested in Australia.

$30 million investment fund launched in Australia (Future Capital Bitcoin Fund) set

to invest in companies that are leveraging Bitcoin and crypto-currency services.

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Global Regulatory Approach to Bitcoins

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Recent Regulatory Developments

California changes laws to declare bitcoin as ‘legal money’.

The UK Revenue Commission considered the supply of bitcoin to be VAT exempt.

Canada changes its AML/CTF equivalent to extend its cover to bitcoins.

European Banking Authority – cautions banks from dealing in bitcoins themselves until the currencies are regulated, but allows banks to continue relationships with bitcoin businesses.

George Osborne the Chancellor of the Exchequer wants London to become the global capital of digital currencies

In Australia ASIC current view bitcoin as a commodity like gold and don’t believe it comes under the financial services remit

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Taxation issues – Digital Currency

Preparer: ADCCA

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Difficulties in applying existing tax law to digital currency

In August the ATO today delivered guidance on the taxation treatment of Bitcoin and other digital-currencies

bitcoin transactions are treated like barter transactions with similar taxation consequences.

Generally, no income tax or GST implications for individuals that use bitcoin to purchase goods or services for personal use or consumption.

Any capital gain or loss from disposal of the bitcoin will be disregarded as a personal use asset – provided the cost of the bitcoin is $10,000 or less.

Businesses will need to record the value of bitcoin transactions as a part of their ordinary income. They must also charge GST when they supply bitcoin and subject to GST when receiving bitcoin in return for goods and services.

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Tax Problems

GST applies to both parts of the transaction

anomalies in dealings between registered and non-registered parties

a taxable supply every time bitcoin is exchanged for another currency

There may be fringe benefit tax consequences for businesses using bitcoin to pay employee salaries.

Definitional problems

‘Used as money, but not officially ‘money’’

What if another country adopts Bitcoin as legal tender? Automatically legitimised as a Foreign Currency?

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Bitcoin as a payment system Innovation & Competition in the payment system

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Settlement Process

Every Bitcoin transaction is recorded on a global register that is

publicly available (blockchain)

Bitcoin to Bitcoin transactions are verified and settled within 4 – 10

minutes

Settlement is final

There is no double spend on a Bitcoin transfer

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Settlement Risk Mitigation

Payment services providers can simultaneously access multiple exchanges to ensure that if one exchange goes down, settlement can be achieved through other exchanges

Decentralised arrangements guarantee the stability of the system, even in the face of currency fluctuation

Transactions are fully transparent, traceable and highly secure

There are inbuilt mechanisms to maintain security of each transaction (i.e. mining process)

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Benefits of Bitcoin

Highly innovative technology

New and emerging technologies are likely to drive change into the market

Open access encourages new entrants (and facilitates innovation)

Safe alternative to existing payment channels (for individuals, small and large business, etc) that complements payment options currently offered by banks

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Digital Currency & AML Harnessing technology to assist in Anti-Money Laundering

and Counter Terrorism Financing Efforts

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AML/CTF Steps

1. Gathering data

2. Authenticating data

3. Reporting suspicious transactions

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AML/CTF for the Bitcoin Industry 1. Gathering data and reporting transactions is not a burden as the

businesses have cutting edge technology that incorporates compliance procedures

2. ACC has offered to create/extend ACORN for DC reporting business (like AUSTRAC)

3. ADCCA Members (such as BTA) have implemented AML + KYC Best Practices in compliance with/or benchmarked against existing legislation

Authenticating Data – the DVS

Under the DVS Access Management policy, business may only use the

DVS if authorised or required under Commonwealth law to identify

their customers.

For example:

Designated services under AML/CTF Act

Cash dealer under FTR Act

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Designated Service – AML/CTF Act

Account/deposit-taking services

Currency exchange services

Electronic funds transfers

Remittance services

ASIC has officially and clearly stated Bitcoin is not a designated service.

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Bitcoin & the AML/CTF Act

Bitcoin is not e-currency (s5):

Not issued by or under the authority of a government body

Not backed by bullion or precious metal

Can be anything considered e-currency by the regulations

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AML/CTF Compliance for the Industry

KYC Compliance is the key to building a robust industry.

Facilitating the growth of compliant businesses will drive traffic through the legitimate channels

The members of the ADCCA are voluntarily incorporating AML/CTF protocols into their systems and processes

For example:

Access to GreenID

Engaged/engaging Auditors

Access to OFAC SDN list

Voluntary reporting of transactions to authorities

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KYC via Edentiti/GreenID (with ‘Safe Harbour’)

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KYC & Bitcoin ATMs (ABA Technology)

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KYC & Bit Trade

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Digital Currency Accounting Control

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Risk of theft and fraud of Digital Currency Assets

Cyptography is used to secure digital currency assets from unauthorised access.

So long as the cryptographic key is protected, access is protected.

The underlying technology is secure, however its improper use can result in

theft and fraud.

To-date, the various cases of theft and fraud of digital currency assets have

arisen mainly from two root causes:

1. Allowing the cryptographic key to be learned by a malicious actor.

2. Theft by an insider who has access to the cryptographic key.

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Accounting Controls for Digital Currency Assets

Auditor’s dream

The block chain is an agnostic third party to verify every transaction, free from human failures and proven strong control around the soundness of the technology.

Government and regulators need to mandate that users are able to be identified via their wallets and vice versa.

A triple entry accounting transaction:

EXAMPLE

Alice pays Bob and Ivan intermediates. Each holds the transaction, making for triple copies.

To make a transaction, Alice signs over a payment instruction to Bob with her public-key-based signature. Ivan the issuer then packages the payment request into a receipt, and that receipt becomes the transaction.

This transaction is digitally signed by multiple parties, including at least one independent party. It then becomes a powerful evidence of the transaction.

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Accounting Controls for Digital Currency Assets

The CEO of the International Federation of Accountants (2.5 million members) Fayez Choudhury suggests that bitcoin could reshape corporate financial ethics, saying:

“The traceability of transactions and nearly all forms of record-keeping tied to them could actually reduce fraud and

force those in key financial roles to ensure responsible behaviour in ways that ethical codes cannot.”

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Q + A

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