Blockchain 101

Featuring:

MNP & The CSE

Date: December 4, 2018

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Page #Slide

Presenters

Maruf Raza, CPA, CANational Director of Public Companies

maruf.raza@mnp.ca

George Huang, CPA, CA

Senior Manager, Public Companies

George.huang@mnp.ca

Richard Carleton

CEO

Richard.carleton@thecse.com

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Page #Slide

AgendaWelcome and Introductions

Part One: Blockchain 101

Part Two: CSE Token Platform

Questions

Closing Remarks

Blockchain 101

Maruf Raza CPA, CA

George Huang CPA, CA

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BITCOIN =/= BLOCKCHAIN, HOWEVER…

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Agenda of this presentation

• What is Blockchain?

• What is Cryptocurrency, tokens, SAFT/ICO

contracts?

• Accounting treatment for digital assets and

revenue

• Audit risks for digital assets

• Crypto mining and crypto mining machines

• Impairment testing for crypto mining machines

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Overview of Blockchain

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Overview of Blockchain• A public “digital ledger”

– Captures transactions

– Between parties in a network

• Internet-based

• Peer-to-peer

• A decentralized ledger

– there is no single point where decisions are made

• A distributed ledger

– Includes all transactions since date of creation

• Transactions are secured by public-key encryption

• Systems use a “consensus algorithm”

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The Block and the Chain

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Example – Bitcoin Public/Private Key

Type Key Length

Private L1NheL9TWaSAdnxCk6y9uVGNrEaS7v7hNXbxytsfuCkvgfTC8rWL 52

Public 17tQEHFj9CcJuKBRoZKKT2GdbDhcgkP27n 34

Hash (SHA-256)

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Wallet – A Collection of Key Pairs

You lose the private key, you lose the Bitcoin!!!

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What Are Cryptocurrencies?

• In March 2018, the word "cryptocurrency" was added to the

Merriam-Webster Dictionary

– “any form of currency that only exists digitally, that usually has no

central issuing or regulating authority but instead uses a

decentralized system to record transactions and manage the

issuance of new units, and that relies on cryptography to prevent

counterfeiting and fraudulent transactions”

• A type of digital asset that exists only on networks - not in physical

form

• Cryptography is used in the generation, storing, transmittal and

verification of transactions of these digital assets

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What Are Cryptocurrencies?

• Examples of Blockchain Network:

– Bitcoin– peer to peer electronic cash system

- Bitcoin is the crypto currency on the network

– Ethereum– transaction, DAPP, Smart Contract

- Ether is the crypto currency on the network

- Many ERC20 Tokens

• Total amount that may be “in circulation” is limited

• Total bitcoin market cap US$75 billion (at Nov 29, 2018)

• Approximately 1,500 different types of cryptocurrencies in existence

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Coins

• Coins are cryptocurrencies operate on their own blockchains

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Tokens

• Tokens are used to interact with decentralized applications that are

built on top of different blockchains.

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Other Uses

ICO

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What is an ICO/ITO/SAFT?

• Initial Coin Offering (“ICO) or Initial Token Offering (“ITO”) can be

very similar to an Initial Public Offering (“IPO”) the public can

purchase Tokens/Coins prior their release to crypto exchanges

• Simple Agreement for Future Tokens (“SAFT”) can be viewed the

same as Simple Agreement for Future Equity (“SAFE”). Which are

used frequently for institutional investors

• Similar to traditional shares of a company because their value may

increase or decrease depending on the success of the business

• Capital is usually raised before a project commences and the project

is then built on the amount of capital raised

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Is a Coin/Token a Security?

• The Canadian Securities Administrators released certain specific

criteria to determine whether or not a coin/token will be considered a

security. They are:

Does an ICO/ITO consist of ...

• an investment of money

• in a common enterprise

• with the expectation of profit

• to come significantly from the efforts of others

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Understanding of Crypto Mining• Block and block rewards

January 27, 2009 – 50 bitcoins

Current rewards – 12.5 bitcoins

Next “halfing” – expected in May 2020

• Hashrate

(1 PH = 1,000 TH = 1,000,000 MH = 1,000,000,000 KH)

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Mining difficulty

• Mining difficulty

Bitcoin network – global difficulty set for all blocks

Difficulty changes every 2016 blocks.

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Types of Crypto Mining

• Solo Mining – mining on your own!

• Mining pool

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Reward systems for pool mining

• Proportional

- Based on actual proceeds pool earns and % share

of hashrate in the pool

• Pay-per-Share (PPS)- Instant and guaranteed payout for each share.

Miners are paid out from the pool’s balance

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Audit and Accounting Implications

– Accounting treatment for Digital Assets

– Accounting treatment for Mining Revenue

– Audit risks related to Digital Assets

– Audit risk related to Mining Revenue

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IDG Jan 10, 2018 Meeting –

Is Cryptocurrency an Asset?The Conceptual Framework under IFRS:

“Asset is a resource controlled by the entity as a result of past events

and from which future economic benefits are expected to flow to the

entity”

Criteria How met?

Past event Entity essentially buys, transacts with, or ‘mines’

a cryptocurrency (i.e., once the cryptocurrency is

bought, traded, awarded or mined

Control Entity is able to control it, as it can decide when

to sell it or use it as a medium of exchange

Future economic benefits Ultimately, a sale or exchange of cryptocurrency

for some other goods or services will result in

benefits

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IDG Jan 10, 2018 Meeting –

Classification of Cryptocurrency Asset

Type Factors supporting the

classification

Factors not supporting the

classification

Cash Cryptocurrency represents a

common medium of exchange

and is widely accepted as a

means of payment across the

globe (similar to cash).

It is not issued or backed by any

government or state.

Cash

equivalent

Cryptocurrency is in the nature

of a short-term, highly liquid

investment that is readily

convertible to known amounts

of cash.

In recent history it has been

extremely volatile, hence there is

a significant risk of changes in

value.

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IDG Jan 10, 2018 Meeting –

Classification of Cryptocurrency Asset

Type Factors supporting the

classification

Factors not supporting the

classification

Financial

asset

Cryptocurrency represents a

right to receive cash or

another financial asset, or to

exchange financial assets

with another entity under

conditions that are potentially

favourable.

It does not give the holder a

contractual right to receive

cash or another financial asset.

There is no corresponding

financial liability in the books of

the party that would honour the

value of the cryptocurrency.

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IDG Jan 10, 2018 Meeting –

Classification of Cryptocurrency AssetType Factors supporting the

classification

Factors not supporting the

classification

Intangible

asset

Cryptocurrency can be sold,

exchanged or transferred

individually; it is not cash, but a

non-monetary asset, with no

physical form.

It is not specifically identifiable (as

defined) because it does not arise

from any contractual or legal rights.

Inventory Cryptocurrency is viewed similar to

a commodity held for trading

purposes in the ordinary course of

business.

It does not have any physical form.

Further it may not be held for sale

in the ordinary course of business.

Investment

Property

Investors hold cryptocurrency for

capital appreciation or as medium

for exchange or both

IAS 40 is limited to real properties

i.e. land and building

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IDG Jan 10, 2018 Meeting –

Measurement of Cryptocurrency Asset• Fair value through Profit or Loss (FVTPL)

– Pro is may reflect current value

– Pro is would reflect volatility

– Con is the recordkeeping and the volatility

• Lower of cost or net realizable value

– Pro is would be simpler

– Con is would not reflect appreciation

• Cost?

– NEVER!

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CPA Canada Position– Intangible Asset*

• CPA Canada concluded

– Not inventory (unless broker-dealer)

– Not financial assets

– Not cash and cash equivalent

– Not investment property

• It appears many cryptocurrencies are likely to meet the definition of

intangible assets and are therefore within the scope of IAS 38

• Revaluation model

– Increase in fair value in OCI

– Decreases in P/L

– No recycling. Meaning net increase in OCI, net decrease in P/L

• Does this make sense?

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MNP Position – Digital Asset, FVTPL

• None of the current standards provide most relevant information to

FS users

– Not inventory (unless broker-dealer)

– Not intangible assets

– Not financial assets

– Not cash and cash equivalent

– Not investment property

• MNP’s current position is that primarily, there is recognition of an

asset measured at FVTPL.

• Sufficient disclosures should be made including significant

assumptions in determining fair value, source of prices etc.

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Measurement of Digital Asset

• Normally a cryptocurrency price can be observed directly from active

markets (Crypto Exchanges)

• Sources of Fair value:

– CoinmarketCap - website that essentially reports market capitalization of various

cryptocurrencies, and use weighed average price of all major exchanges by

trading volume

– Crypto Exchanges – Bitfinex, Binance, Coinbase (GDAX), Huobi, OKEx

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Disclosure of Digital Asset

• Type and quantity of cryptocurrency is held

• Historical cost

• Fair value (IFRS 13 disclosures)

• Valuation methodology and technique (IFRS 13 disclosures)

• Purpose for holding

• Risk factors

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IDG June 21, 2018 Meeting –

Crypto Mining Revenue

Two types of mining income

• Transaction fee (relatively immaterial)

Transaction fees are paid by party initiating the transaction to miners for their efforts

in validating the transaction

• Block reward (more material)

The reward paid to winners who first solved the has functions to generate a block

Solo mining – miners running full nodes and try solving the function individually

Pooled mining – pooled computing powers of many miners for higher

probability of solving the block

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IDG June 21, 2018 Meeting –

Transaction Fee as Revenue

Most group members agree the transaction fees can be can be

recognized as revenue according IFRS 15. Although there is no explicit

contract between the miner and party initiating the transactions

because of the nature of blockchain network, there is a common

understanding that the miner solving the algorithm and creating new

block is entitled to a transaction fee.

And amount of electricity and computer hardware required support it is

a business operation other than a casual investment.

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IDG June 21, 2018 Meeting –

Block Rewards Solo Mining as RevenueFor

• Common understanding block reward is paid to miner who create

the next block

Against

• There is no direct relationship between customer and miner. As a

result there are no enforceable rights and obligation that may be

enforced against any individual identifiable party

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IDG June 21, 2018 Meeting –

Block Rewards Pool Mining as RevenueFor

• Miners in pool agree the terms and conditions with pool operators

and pay administration fees to the pool operator

Against

• Pooling arrangement may essentially be a form of joint arrangement

among the participants. It is difficult to conclude that there is a

contract to provide series to pool.

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MNP Position – Revenue

Crypto mining is the ordinary business activity of the entity

Consideration received meets the definition of revenue

While no explicit contractual relationship between the parties, the

substance of the arrangement in such the rights and obligations of each

party in the blockchain protocol is implied by the customary business

practices and processes prevalent in the industry

The nature of blockchain protocol is not possible to determine in

advance the consideration that will be received, a reliable estimate of

outcome of such activity cannot be made in advance of actual receipt

due to uncertainties

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Example FS – Balance Sheet

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Example FS – Income Statement

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Example Disclosure – Significant Judgement

and Estimate

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Example Disclosure – Significant Accounting

Policy

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Example Disclosure – Digital Asset Note

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Audit Considerations – CPAB

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Audit Considerations – CPA Canada

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MNP Audit Approach - Existence

• Obtain a list of crypto wallets (including both hot and cold)

• Validate balance on block explorers (use more than one to corroborate)

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MNP Audit Approach

• Compared to price used by the Company to value the digital

assets against independent source

• Assignment agreement proving the Company owns the wallets

• Test the ownership of private keys

– Observe login

– Observe cryptocurrency transfer

• Management representation of all crypto wallets

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Crypto mining machines

• Bitcoin mining difficulty

• Generations of bitcoin mining equipment

- Mid 2015 – Bitmain Antminer S7 – 4.73 TH/s

- Mid 2017 – Bitmain Antminer S9 – 13.5 TH/s

- Early 2018 – Bitmain Antminer S9i – 14.5 TH/s

- Nov 2018 – Bitmain Antminer S15 – 28 TH/s

• 2 to 3 years useful life

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Price of Crypto mining machines

• Jun 2017: Bitmain Antminer S9 - $1,500

• Jan 2018: Bitmain Antminer S9 - $3,500,

to be shipped in 6 weeks

• And today?

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Today – Bitmain S9

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Impairment testing

• Cash inflow

– Using PPS formula based on the total

hashrate provided by the machines

• Cash outflow

– Electricity bill

– Rent

– Labour

– Maintenance of machines

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Estimating future cash inflow

• Use current (Y/E) price of BTC

• Use current (Y/E) mining difficulty

• Perform and disclose the sensitivity information

– Bitcoin price +/- $1,000

– Bitcoin mining difficulty +/- 100%

Miner's hashrate * Block rewards * 86,400 (Seconds per day)

BTC earning per day = --------------------------------------------------------------------------

BTC difficulty * 2^ 32

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Key assumptions

• Expected halfing in May 2020

• Useful life for mining machines: 2 to 3 yrs

• Bitcoin mining difficulty changes approximately

every two weeks

• Bitcoin trades 7 days a week not 5 business

days – for bitcoin price volatility calculation

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Resources

Securities Regulation

• CSA Staff Notice 46-307, Cryptocurrency Offerings

• SEC Investor Bulletin: Initial Coin Offerings

MNP

• White Paper - Cryptocurrency – Accounting Implications

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Resources

CPA Canada

• Blockchain Technology and Its Potential Impact on the Audit and

Assurance Profession

• Technological Disruption of Capital Markets and Reporting? - An

Introduction to Blockchain

• Navigating the Brave New World of Cryptocurrency and ICOs

• An Introduction to Accounting for Cryptocurrencies

• IFRS Discussion Group Report - Cryptocurrencies

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CSE Blockchain Platform

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CSE Blockchain Platform

Richard Carleton

TODAY’S DISCUSSION

Why Blockchain in the Exchange World:

• Benefits for issuers

• Opportunities for public investors

• Investment dealer perspective

• The CSE’s approach

What’s in it for the issuers?

Securities tokenization will reduce cost of capital and revolutionize

shareholder relations and communications:

• Visibility of beneficial shareholders (communications, peer

analysis and proxy voting costs reduced)

• Tax on “entitlements” sharply reduced: private equity deals

become doable in the public markets

• Disintermediation of some service providers (?)

Public Investors

Outside of the cannabis sector…what’s compelling about

Canadian equities?

Blockchain will enable companies to launch new and innovative

investment products on Canadian exchanges:

• Streaming royalties for the mining and O&G sector

• IP portfolio securitization: mortgages and real estate, patents,

trademarks and copyright (music, movies, images)

Dealer Opportunities

21st century back office processes would be recognizable to 19th

century denizens of the “counting houses”:

• T+2 instead of T+5

• Capital posted against open positions

• Short sale transactions: no visibility for companies

• Mistakes are expensive and time consuming to correct

THE CSE’s Approach

Provide a safe, regulated place for innovators and entrepreneurs

to use the power of the blockchain to reduce capital costs for

issuers:

• Provide an Ethereum-based private blockchain powered

network to support a new clearing and settlement facility

• Use the existing exchange license to list “tokenized securities”

of Canadian reporting issuers

The CSE’s Approach

• Place the blockchain behind the securities industry “firewall”:

same network as trading

• Hashing turned to zero for performance reasons

• Dealers and intermediaries issued digital wallets to receive

and provide information from the blockchain

• Tokens will be held in “deep cold storage” forever, digital

representations of tokens and cash update the chain

Timing and Next Steps

• CSE is in late stages of internal QA with the application

• Dealers (et al) will be issued digital wallets; system will be

available for full life cycle testing very shortly

• Integration with existing cash and customer account reporting

will be the principal challenge

• 6 to 9 month approval process from the regulators

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Thank You

www.mnp.ca