Blockchain 101
Featuring:
MNP & The CSE
Date: December 4, 2018
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Presenters
Maruf Raza, CPA, CANational Director of Public Companies
George Huang, CPA, CA
Senior Manager, Public Companies
Richard Carleton
CEO
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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