Cryptocurrencies and mining have taken off at surprising speed over the last year with profits to be made but many of the systems and safety nets are still catching up with the rapid development.
Joseph Bonvillain, a partner at the Vancouver-based public accounting firm Manning Elliott, says there are a number of challenges regarding cryptocurrency mining that people are not always aware of despite widespread interest in the topic.
“It’s a really big headline generator and hot topic right now,” says Bonvillain. “We’ve been posed lots of questions and it’s definitely challenging in general for people to understand.”
In part, the challenge arises from the elusive nature of the digital currency itself.
“You’ve got something that exists only virtually, and it’s got valuation or liquidity issues and major volatility,” explains Bonvillain.
Big gains, big losses
Bitcoin, the most well-known cryptocurrency spiked from $900 to $20,000 per coin within roughly a year and then mere months later, dropped to where it currently stands at closer to $9,000 per coin.
Volatility is only the tip of the iceberg when it comes to challenges and, on the flipside of the losses, the potential of spikes and sudden financial gain are part of the appeal.
“People are always interested in how to make money,” says Bonvillain. “There have been some large profits that have been generated within the past year or so and that always sparks a lot of interest.”
But the same reasons that make cryptocurrency and mining tricky to fully comprehend also pose a similar challenge to track and audit once those profits are made because the processing of the transactions for miners has an automated validation system.
“Traditionally, what auditors are required to do is independently verify that something has actually occurred but here you are trying to verify a transaction that you can’t observe so its leads to unique things,” says Bonvillain.
‘The entire system poses a challenge’
Blockchains – the technology that virtual currencies like Bitcoin are based on – have no central administration and so anyone with the right specialized mining hardware can process the transaction.
Only a digital signature, the cryptography, protects its validity and authenticity.
In essence, this means that blockchains are tricky to audit using the typical means and so, as the cryptocurrencies take off, it is becoming more and more of a problem for companies.
“We do a lot of work with public companies and also with investors, some of which are actual miners,” says Bonvillain. “Now these companies want to go public or people are looking at verifying income and the entire system poses a challenge.”
Companies need to think ahead to face these issues to avoid being caught out, Bonvillain emphasizes.
“Things really need to be formalized,” he says. “They need IT security specialists and a whole number of people working on a system that can then be audited.”
Considering tax implications
The same consideration of the future implications of mining is true for individual investors too, Bonvillain adds.
“A challenge that a lot of people don’t realize is that they have to think about the end results and what’s going to happen when they are filing taxes,” explains Bonvillain.
The rapper 50 Cent, for example, claims that he “accidentally” made $8 million in bitcoin. That has significant tax implications, Bonvillain points out.
At the end of the day, cryptocurrencies aren’t going anywhere, but the financial and technological systems from auditing to meeting electricity needs will need time to catch up.
“It’s really picking up, Vancouver has a number of newly listed companies and a whole number that are in the process of listing,” says Bonvillain. “I think this is here for the long term.”