Cryptocurrencies & Regulation
November 2017
“Distributed Ledger Technology” is the
technology behind BlockChain
Copyright © 2017 Deloitte Touche Tohmatsu India LLP
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BlockChain lends itself to multiple usecases – One of which is Crypto Currency
Copyright © 2017 Deloitte Touche Tohmatsu India LLP
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BitCoin is one among a larger number of
Crypto Currencies. Other examples would
be Ethereum, Ripple, LiteCoin, Monero,
Dash, Augur…
Copyright © 2017 Deloitte Touche Tohmatsu India LLP
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Significant Global Traction and Challenges
Blockchain
Global Interest
24+
countries
currently
investing in
blockchain
Research
2500+
patents filled
in last 3 years
Consortium
Efforts
90+
corporations
have joined
blockchain
consortia
Central Banks
90+
central
banks engaged
in blockchain
worldwide
Venture Capital
Over US$
1.4
billion in
investments over
past 3 years
Investment
Experimentation
2225
of 500*
asset
managers are at
least
experimenting with
block chain
technology
*2016 survey by Roubini Though Lab
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Significant Global Traction and Challenges
Last Five Days
The Crypto Currency World is changing much faster than we
may assume… It’s most likely in our backyard.
•
Malaysia’s Central Bank to Decide on Crypto Regulation at Year’s End
•
Russia Has Found Best Location for Crypto Miners
•
Singaporean Mining.sg Reports Increasing Hardware Demand
•
Iranian Government Preparing for Bitcoin Use Inside the Country
•
Over One Million People Enroll in Online Crypto Class
•
Bitcoin Cash Hard Fork Plans Updated – New Difficulty Adjustment
Algorithm Chosen
•
80,000+ Blockchain Projects, 8 Percent Survive
Source: www.bitcoin.com
Copyright © 2017 Deloitte Touche Tohmatsu India LLP
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Agenda
1. Crypto Currencies &
EcoSystem
2. Market & Regulatory
Landscape
3. Risk Framework on
BlockChain
© 2017 Deloitte Touche Tohmatsu India LLP
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Getting familiar
Bitcoin is a decentralized, digital currency that is created and held electronically and operates independent of a central authority or any
financial institution. Bitcoins can be exchanged for goods or services, or converted to other currencies.
HOW DO BITCOINS WORK?
Bitcoin creation
Bitcoins are created by an open
source community of
programmers called miners
Miners use their computing
power, programming skills, and
time for creating Bitcoins. This
process is called Bitcoin mining
•
•
Bitcoin access
•
Once Bitcoins are created they
can be purchased by users
with traditional currency
through Bitcoin exchanges
(online platforms to access
Bitcoins) or ATMs ( physical
machines that allow
conversion to Bitcoins)
Bitcoin storage
•
•
Bitcoins are stored in digital
wallets on devices such as
mobile phones or computers
Each wallet has an address,
with a unique key that can be
used to access funds or
initiate transactions
HOW ARE BITCOINS DIFFERENT FROM TRADITIONAL CURRENCIES?
Bitcoins differ from the traditional currencies on the basis of their characteristics
and usage as below:
CHARACTERISTICS
•
•
•
•
Crypto-currency: Encryption techniques are
used to regulate the generation of Bitcoins and
verify funds transfer
Anonymous: Users can hold Bitcoin wallets
without revealing and verifying their identities
Transparent: As all Bitcoin transactions are
stored in a public ledger, (also known as block
chain) the Bitcoin network is transparent
Non-reversible: Payments made in Bitcoins are
irreversible. Unless the recipient sends the
Bitcoins back, there is no way of retrieving them
© 2017 Deloitte Touche Tohmatsu India LLP
USAGE
•
•
•
Easy to set up: Unlike traditional bank
accounts, Bitcoin accounts are easier to set up.
An online wallet can be acquired with no fees
Speed of transaction: Bitcoin money transfers
take about 10 minutes to be processed where as
traditional currency international transfers can
take about one or two days
Miniscule transaction fees: Bitcoin money
transfers charge very low or no transaction fees
at all
Bitcoin usage
•
•
Bitcoin wallets can be
used to make payments
mainly in the world of
ecommerce, online
gaming, and media
A few examples include
Dell, Expedia, Newegg,
and Time
Bitcoin conversion
•
•
In addition to buying goods and
services Bitcoins can also be
converted to other currencies
based on market value (which
depends on multiple factors)
Bitcoins can also be leveraged
for trading and making
investments
HOW HAS THE BITCOIN ECONOMY GROWN SINCE ITS INCEPTION?
Bitcoins are expected to redefine financial and commercial businesses. In CES 2015 the
World of Bitcoin event had 10 Bitcoin companies (collectively representing $100 million
venture funding) showcase Bitcoin potential. Some data points to represent this growth:
Total merchants accepting
Bitcoins as of Dec’14
82,000
This number has grown by 2x
in one year
Market capitalization of
Bitcoins as of Oct 17
$96.7 billion
Total number of Bitcoin
wallets from inception to
Oct’17
18 million
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Understanding the ecosystem and emerging players
BITCOIN ECOSYSTEM*
New players that provide Bitcoin-related support or services continue to emerge due to increased funding from venture capitalists and investors. Rise of new Bitcoin-centric business
models has further resulted in a dynamic landscape.
Emerging players in each category
Bitcoin Creators: Players that contribute to making Bitcoins
• Bitcoin miners are individuals who manage the Bitcoin network to receive rewards in Bitcoins
• Any individual can mine Bitcoins by setting up Bitcoin mining infrastructure and joining dedicated groups
of programmers known as mining pools
• Specialized Bitcoin mining hardware is provided by mining equipment providers are companies such as
Butterfly Labs
Bitcoin Creators
Mining
equipment
providers
Bitcoin
miners
Bitcoin Facilitators
Bitcoin
ATMs
Bitcoin
exchanges
Bitcoin
wallets
Bitcoin
payment
providers
Bitcoin Service Providers
Bitcoin-related
professional services
Bitcoin-related
financial services
Stakeholders
Banks and
financial
institutions
Regulators
Bitcoin
advocacy
groups
© 2017 Deloitte Touche Tohmatsu India LLP
Merchants
and end
users
Bitcoin Facilitators: Players that provide requisite infrastructure to store, exchange, and transact Bitcoins
• Bitcoin ATMs such as Lamassu and Robocoin provide physical machines that allow traditional currency
conversion to Bitcoins. Currently, 1587 Bitcoin ATM machines have been installed worldwide
• Bitcoin exchanges are platforms such as BitStamp where users buy and sell Bitcoins into other currencies
• Bitcoin wallets such as CoinBase are digital addresses for users to safely store Bitcoins
• Bitcoin payment providers are players such as GoCoin that facilitate payments in Bitcoins
Bitcoin Service Providers: Specialist service providers that help businesses and individuals get Bitcoincentric information and financial value
Service firms
• Companies that consult firms around operations, tax, and compliance such as LibraTax, XenAccounting
• Companies that provide specialized HR related services such as Bit Recruiter for digital currency talent
acquisition or process employee payrolls in Bitcoins such as WagePoint
• Companies that provide block chain analytics services such as Coinalytics, BitsofProof
Financial services firms
• Companies that provide bank-like services - Bitcoin loans and remittances such as BitLendingClub and
companies that provide Bitcoin related investment opportunities such as iCBIT
Stakeholders: Entities actively involved in shaping the Bitcoin landscape such as Regulators** and Bitcoin
advocacy groups***, entities with the potential of getting disrupted due to Bitcoins such as financial
institutions, and entities which control the adoption of Bitcoins such as merchants and consumers
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Simple Industry Applications of Blockchain
“Nasdaq Unveils Blockchain –Enabled Platform Linq,
Announces six Inaugural Clients.”
“Ripple – New Banking Group is first Blockchain Based
Settlement Network.”
“Thomson Reuters Demos New Etherum Blockchain Use
Cases.”
“Visa Introduces International B2B payment Solution
Built on Chain’s Blockchain Technology.”
Leading global
originations across
industries are
collaborating to share
risk while reducing
transaction costs.
“Microsoft and Bank of America Merrill Lynch
collaborate to transform trade finance transacting with
Azure Blockchain as service.”
© 2017 Deloitte Touche Tohmatsu India LLP
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Understanding the key forces actively shaping the ecosystem
Increase in number of merchants and payment processors who accept Bitcoins
•
Companies such as Microsoft, Dell, Overstock, Dish TV, and Expedia now accept Bitcoins as payments for their products and services
•
PayPal, a leading payments company, allows its customers to accept Bitcoin payments for digital assets
Easier access to Bitcoins
•
Increase in number of Bitcoin ATMs in Canada and US with Bitcoin ATM manufactures such as Robocoin and Lamassu now implementing compliance protocols like anti-fraud &
Know Your Customer (KYC) norms
•
Rise in number of Bitcoin exchanges such as Kraken and Bitstamp. These exchanges are implementing regular audits for compliance with regulatory protocols
•
Increase in total number of secure wallet providers such as CoinBase and Xapo
•
Convergence of Bitcoins with trends such as wearables in the form of Bitcoin wearables allow users to make micro payments easily with just a swipe
Increased funding from venture capitalists and support from Bitcoin advocacy groups
•
Advocacy groups such as Bitcoin Foundation are acting as influencers. They are interacting with regulators and key players in the Bitcoin ecosystem to drive awareness as well as
commercial adoption
•
Accelerators such as Plug and Play are providing Bitcoin startups with required expertise, funding, and infrastructure
•
Google Ventures has recently invested in OpenCoin, a start-up responsible for developing a global Bitcoin exchange network
Rising number of crypto currency specialists
•
Rise of crypto currency specialists has facilitated the development of various Bitcoin focused applications and services
•
Bitcoin recruitment agencies such as Honey Badgr and Bit Recruiter are helping organizations source talent
•
Bitcoin related courses for professionals are now being offered by Crypto Currencies Certification Consortium
Dynamic regulatory developments around Bitcoins
•
Several regulatory bodies such as Internal Revenue Services (IRS) and Consumer Financial Protection Bureau (CFPB) are clarifying their stand on Bitcoins
•
SEC has issued alerts cautioning investors against Bitcoin related Ponzi schemes while closely monitoring Bitcoin ventures which issue securities without registering with them
•
In May 2014, the Federal Reserve indicated that Bitcoin could be potential boon for global commerce, if regulated well. However, they also state that they do not have the
authority to regulate Bitcoins
•
In Jan 2017, New York State Department of Financial Services (DFS) grants license to virtual currency businesses
© 2017 Deloitte Touche Tohmatsu India LLP
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Recognizing client concerns and challenges
MARKET SPEAKS
“Virtual currencies are not backed by any
government or central bank, and at this
point consumers are stepping into the
Wild West when they engage in the
market”
Richard Cordray, Director,
Consumer Financial Protection
Bureau, on volatile virtual
currencies market
“A new product, technology, or
innovation – such as Bitcoin – has the
potential to give rise both to frauds
and high-risk investment
opportunities”
Investor Alert by U.S. Securities
and Exchange Commission
(SEC) to make investors aware
of the potential risks of
investments involving Bitcoins
KEY CONCERNS AROUND BITCOINS
Getting banks on board is
challenging. The banks are usually
skeptical when it comes to offering
accounts to Bitcoin startups. It’s a hard,
difficult process to convince them and
involves lots of meetings
Brian Armstrong, Co-founder of
Coinbase, on banks providing
financial services to Bitcoin startups
“Expect to see continuing fluctuations
in Bitcoins… we can see a lot of chaos
and drama as the Bitcoin eco-system
works itself out”
•
REGULATORY UNCERTAINTY
Lack of universal approach and regulatory clarity around Bitcoins is holding back
organizations. In the U.S., each state has separate laws and approaches for Bitcoins. While
California and New York have aggressively worked to embrace Bitcoins, other states such
as New Mexico and South Carolina have not regulated money transmitting businesses.
•
SECURITY ISSUES FACED BY BITCOIN EXCHANGES AND WALLETS
Organizations in the Bitcoin ecosystem are vulnerable to cyber attacks that can wipe off
millions of dollars worth of digital currency. The fall of Tokyo based Bitcoin exchange Mt. Gox
that lost $425 million worth of digital currency was the first such case that highlighted
these technology risks. Recently, a Canada-based exchange Flexcoin also went down due to
flaws in their software code causing losses of over 440,000 euros due to hacking.
•
UNSTABLE VALUE OF BITCOIN AS A CURRENCY
Due to absence of a central monetary policy and remedial measures, there are high
investor risks if a Bitcoin exchange collapses. This can expose Bitcoin investors to significant
downside risks due to market volatilities and fluctuations. For example: The value of
Bitcoins raised from a low of $807 in December 2016 to being priced at $7693 as of
November 17, 2017.
•
USE OF BITCOINS FOR UNLAWFUL ACTIVITIES
Unlike centralized digital currencies such as eGold and WebMoney, Bitcoin is decentralized
and unregulated. However, policy makers are concerned about criminals using Bitcoin for
illicit activities without being traced. Recent criminal investigations against Silk Road, an
online black-market for drugs revealed how Bitcoins were being used for payments due to its
anonymous nature.
•
FRAUD AND MONEY LAUNDERING
In early 2014, the arrest of BitInstant founder for money laundering worth $1 million
highlighted the role of Bitcoins as a facilitator of money laundering practices. Recent
technological developments such as the Dark Wallet application can further fuel the use of
Bitcoins for such fraudulent practices.
Gavin Anderson, Chief Scientist
(Bitcoin Foundation) on evolution
of Bitcoins
Preliminary analysis indicates that clients are struggling to understand various Bitcoin related risks for their businesses due to rising incidents of fraud, money laundering, and complexity
arising from unique characteristics of Bitcoins that make it more vulnerable than traditional currency.
© 2017 Deloitte Touche Tohmatsu India LLP
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Exploring potential risk implications for clients
Risk Domains
STRATEGIC RISK
FINANCIAL RISK
OPERATIONAL RISK
Illustrative risks
Examples of manifestation
Reputation risk for established companies due to
involvement with new players with unproven reputations
•
Winklevoss brothers invested in BitInstant due to its CEO’s reputation which was hit when
he was charged with involvement in illicit trading activities
Paralysis of strategic decision making owing to
regulatory uncertainties
•
Bitcoin companies are wary of regulatory uncertainties and are actively seeking help from
players such as CoinX to enhance decision-making
Misreporting due to lack of understanding of revenue
recognition and tax reporting of Bitcoins
•
Companies have published insights on IRS guidelines to make clients aware of tax
implications for businesses dealing in Bitcoins
Risk of illegal activities due to occurrence of fraudulent
Bitcoin investment schemes
•
Trendon Shavers, known operator of the Bitcoin Savings and Trust (BTCST), was fined
$40m for defrauding investors in a Bitcoin Ponzi scheme of 700,000 Bitcoins worth $4.5
million
High volatility risk in valuation of Bitcoin assets
•
Due to the speculative nature of Bitcoins, the Bitcoin price has been varying widely
between Jan’16 – Jan’17. These significant price fluctuations might have led to a loss of
investments for multiple investors
Increased risk of investment loss due to irreversible
nature of Bitcoin transactions
•
As per Wired.com, irreversibility of Bitcoin transactions is a major flaw as it may cause
investor losses. For example : A European Bitcoin payment processor lost $1M and could
not recover the lost Bitcoins
High risks due to dependencies on third parties
(partners, vendors etc.) for running Bitcoin operations
•
Overstock currently depends heavily on its partner Coinbase to convert Bitcoin payments
to dollars after a purchase
Threat of intellectual property claims by third parties
•
As per Winklevoss Bitcoin Trust registration statement filed with the SEC, Bitcoins being
open source projects are vulnerable to IP litigations. Third parties may assert intellectual
property claims relating to the holding and transfer of Bitcoin related assets
Lack of talent to explore the full potential of Bitcoin
technology
•
Demand for crypto currency specialists i.e. web/mobile developers and engineers with
domain knowledge has resulted in companies such as Coinality coming up
© 2017 Deloitte Touche Tohmatsu India LLP
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Exploring potential risk implications for clients
Risk Domains
TECHNOLOGICAL
RISK
Illustrative risks
Examples of manifestation
Cyber risks due to rise in number of cyber attacks on
private keys used for Bitcoin transactions
•
Companies such as BitGo, Inc. have developed platforms to enhance safety of Bitcoins
through a multi-signature, multi-user wallet with built-in corporate policies that require
multiple approvals
Threat of Bitcoin mining malware/ spyware/
grayware by cyber criminals to mine for Bitcoins using
stolen computing power
•
Many security products and solutions have been launched in the market such as Trend
Micro™ which help to detect and delete all known malware associated with involuntary
Bitcoin mining
Security risks due to hacking of digital wallets that
are often used to store Bitcoins in the cloud or on mobile
devices
•
A phishing attack targeting 30,000 Bitcoins was successful at lifting 100 Bitcoins from one
user wallet
Risk of technology disruptions due to non resilient
infrastructure
•
Mt. Gox collapse due to non secure infrastructure led to a loss of $460 million. The
exchange had been hacked twice before the final meltdown. This highlights the risks due
to unproven capabilities of companies in Bitcoin space
Failure of Bitcoin network infrastructure to deal with
high volume of transactions
•
According to Forbes, cropping up of BitcoinStore.com and Overstock will give rise to
resource-intensive transactions that might burden the Bitcoin network leading to failures
Risk from global, regional regulatory differences and
interpretation of Bitcoins
•
Every state in the US has a different take on Bitcoins. Further, UK’s tax authority
announced treating Bitcoins as a single-purpose face-value voucher while Japan plans to
monitor the illegal activities without regulating the digital currency
Inability to understand and deal with evolving
regulatory standards
•
Recently, FinCEN issued a mandate for Bitcoin companies to be considered as money
service businesses (MSBs). This affected players such as payment processors as it required
additional compliance with stringent Bank Secrecy Act regulations
Inability to track money laundering due to anonymous
nature of transactions
•
Bitcoin users moving large sums of money through LocalBitcoins.com were booked under
anti money laundering (AML) charges. This highlighted the increased need for awareness
around Know Your Customer (KYC) and AML norms
REGULATORY RISK
Regulatory risks have been identified as a key area of concern for players in the Bitcoin economy. In fact, regulations took the center stage at the Bloomberg Bitcoin event in
November, 2014.
© 2017 Deloitte Touche Tohmatsu India LLP
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Market &
Regulatory
Environment
© 2017 Deloitte Touche Tohmatsu India LLP
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Regulatory Response to Blockchain
Central
Banks
Regulators
Domestic and foreign regulators as well as central banks have been receptive to blockchain’s Transformative capabilities and are starting to
take steps to regulate the technology
Securities and Exchange Commission
• Some concern about use of “permissionless”
blockchains.
• In 2015 approved the issuance of securities on
blockchain based trading platform.
• Actively seeking comments on use blockchain
technology within federal securities
regulations, specifically around transfer and
clearing agencies
Commodity and Futures trading
Commissions
• Advocated for uniting global
regulators
• to provide oversite for blockchain
• technology so as not inhibit its growth
with multiple , unsynchronized
regulations
Federal trade commission and
Department of Commerce
• Working in collaboration with National
Institute of Technology, Standards
members of
• Congress, and educational group to publish
a white paper in October which
outlines blockchain based model that
can address concerns regulatory entities
Financial conduct authority(UK)
• Launch a “regulatory sandbox” which allows firms to test their
blockchain platforms without incurring all of the normal regulatory
consequences .
• Additionally they are considering approving “significant number of
firms” to utilize their blockchain platforms in a commercial manner.
European securities and Market authority
• Published a discussion paper citing blockchains many benefits but
was also openly critical of “permissionless” blockchains
The Federal Reserve
• Chairwomen Janet Yellen and other Fed members have spoken
favorably of Blockchain technologies improving financial
system adding safety and resiliency.
Bank of England
• Opening its own FinTech incubator to explore new concepts
from blockchain technology.
• Mark Carney(Governor of BoE) has publically spoken in favor of
applying blockchain to its Real Time Gross Settlement (RTGS)
system.
© 2017 Deloitte Touche Tohmatsu India LLP
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Regulation Status in Various countries
The legal status of cryptocurrency varies from government to government and is still undefined or changing in many of them.
Cryptocurrencies’ status as money or as commodities varies, with differing regulatory implications. While some countries have
explicitly allowed the use and trade of these digital currencies, others have banned or restricted them.
Countries
Status
Russia
•
•
Russia might legalize bitcoins and other cryptocurrencies.
Russian Central Bank reported that the regulator and other ministries were developing a joint position on the status of
cryptocurrencies
Japan
•
•
Regulators proposed handling virtual currencies as methods of payment equivalent to conventional currencies.
Government officially recognized Bitcoin as a method of payment.
China
•
Governmental crackdown of Chinese-based digital currency exchanges, causing a suspension in all withdrawals, causing
the market to suffer heavily with China being one of the top Bitcoin markets in terms of trading volume.
US
•
•
•
Classified Bitcoin as a convertible, decentralized, virtual currency
Legality depends on the individual states
The bill was also aiming to regulate and ban the use of cryptocurrency for money laundering.
Saudi
Arabia
•
•
Bitcoin is not banned
Authority has warned of using it, as it is a high risk asset
EU
•
The European Commission is currently conducting a risk assessment on terrorist financing and money laundering,
paying particular attention to virtual currencies.
Malaysia
•
•
Virtual currencies are not legal tender, are unregulated, and deemed as risky.
The Central Bank of Malaysia deems Bitcoin as not being legal tender, and does not regulate the operations of Bitcoin.
© 2017 Deloitte Touche Tohmatsu India LLP
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Financial regulators seem generally excited by the positives of
Blockchain, but there are still concerns over illicit activity
Regulator
Summary
FCA
•
FCA launched Project Innovate to help businesses deal with the regulatory hurdles to launching new financial products,
including Blockchain securities
OCC
•
OCC has published a whitepaper which covers the framework to evaluate innovative products like Blockchain, services, and
processes that require regulatory approval and identifies potential risks associated with them
UK
Treasury
•
European Commission has proposed that draft amendments to the Fourth Anti-Money Laundering Directive be agreed and
implemented by December 2016 requiring that virtual currency exchanges and electronic wallet providers carry out customer
due diligence and have a compliance regime in place
But the UK Treasury reported that a large number of Member States have concerns about this timetable and it seems likely
that implementation will be delayed
•
HKMA
•
•
Hong Kong Monetary Authority (HKMA) warns banks and financial institutions that the implementation of decentralized
Blockchain networks may increase money laundering risks, creating an ideal environment for the emergence of criminal
activities and illicit transactions
They state that the anonymous and decentralized characteristics of the Blockchain technology may lead banks into conflicts
with financial regulations and KYC policies, particularly if banks are not able to manipulate and control the transactions
MAS
•
The Monetary Authority of Singapore (MAS) is partnering with blockchain technology company R3 and a consortium of
financial institutions to develop a proof-of-concept project that would allow inter-bank payments using blockchain
IRS
•
Although the IRS issued guidance in March 2014 concerning income from bitcoin and "virtual currencies" there has been no
enforcement mechanism to ensure that bitcoin income is actually reported to the IRS
Having failed to create an enforcement mechanism, the IRS issued a John Doe summons authorized on 30th November
demands that Coinbase provide complete transaction records for all users between 2013 and 2015
•
© 2017 Deloitte Touche Tohmatsu India LLP
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Security regulators have taken a mixed stance on how
Blockchain technology should be viewed and regulated
Regulator
Summary
SEC
•
•
•
•
In a sign of how serious state powers are taking the emergence of blockchain, the SEC now has a working group dedicated to
protecting its users and investors from fraud in the sector
The SEC's Specialized Working Group on Equity Market Structure has its own Blockchain Task Force. Employees continue work
on their cases while keeping an eye open to how blockchain impacts other divisions of investment management or trading and
markets
According to SEC regulations, Bitcoin cannot be considered as a Security for purposes of § 2(a)(1) of the Securities Act
However, SEC is considering whether Blockchain applications require registration under existing Commission regulatory
regimes, such as those for transfer agents or clearing agencies, and has requested comments from Industry participants
CFTC
•
CFTC (Commodity Futures Trading Commission) is bringing Bitcoin under its jurisdiction by treating Bitcoin like a commodity
and therefore, regulations applicable to Futures will be applicable to Bitcoins
ASIC
•
ASIC chair, Greg Medcraft, states that distributed ledger technology such as Blockchain could result in greater efficiency and
speed, disintermediation, reduced transaction costs, and improved market access
ESMA
•
European Securities and Markets Authority (ESMA) will soon have the power to ban blockchain or distributed ledger technology
(DLT), come January 1, 2018. It was involved in the setting up of a “DLT Task Force” which saw participation from other
agencies including the European Commission and the European Central Bank
ESMA has established a Financial Innovation Standing Committee to seek a harmonized approach amongst European national
supervisory authorities to the supervision and regulation of innovative products
Verena Ross, director of ESMA, spoke of a desire for a “balanced regulatory response” that assessed both the potential benefits
of the blockchain technology and addressed barriers to entry while identifying potential risks and mitigating them
•
•
© 2017 Deloitte Touche Tohmatsu India LLP
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Central banks are have begun to thoroughly explore potential
applications of Blockchain and how it may affect their purview
Central Bank
Summary
Federal
Reserve
•
•
Federal Reserve governor Lael Brainard delivered a speech on blockchain, remarking that the technology could have a major
impact on the financial system
Brainard’s detailed developments from a Federal Reserve guided working group that is focused on financial innovation, an
effort that is looking at using the tech in next-generation payment and settlement systems
ECB/BOJ
•
•
The European Central Bank is weighing the use of distributed ledger tech in partnership with Japan’s central bank
The two institutions plan to explore the tech over the next months, with an eye to publish the results of its research sometime
next year. The ECB has also formed an internal task force focused on distributed ledgers
Bank of
England
•
UK’s Financial Conduct Authority, has expressed a desire to explore the blockchain technology’s use in financial services
beyond the domain of virtual currencies
The Bank of England has said that the application of distributed ledger technology could have “far-reaching implications” for
the operation of financial services
•
Riksbank
•
•
Bank of
Russia
•
•
•
The
Dutch
Bank
•
•
Sweden’s Riksbank is launching a project to examine what a central bank-backed digital currency would look like and what
challenges it would pose
It hopes to take a decision on whether to start issuing what it calls an ekrona in the next two years. The central bank has
placed much attention on Blockchain as the technology to be used in the digital currency
The Bank of Russia has developed a technical prototype called ‘Masterchain’. The prototype is based on Blockchain technology
for the Russian financial market
The prototype was developed for financial messaging between banks in the Russian financial system. The platform enables for
“prompt confirmation of data actuality” to a transacting customer
The innovation also makes instant communication possible between counterparties among the platform, while assuring
confidence in financial transactions
At the headquarters of the Netherlands’ central bank in Amsterdam, Ron Berndsen set up five laptops to run an experimental
virtual currency derived from the Bitcoin software
Mr. Berndsen operated the Dukaton system for three months to see what would happen if the central bank were setting the
rules and did not have the same limits as Bitcoin
© 2017 Deloitte Touche Tohmatsu India LLP
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Entities outside the world of financial regulation have also begun
to explore how they can leverage Blockchain technology
Entity
Summary
State of
Delaware
•
•
More than six out of 10 Fortune 500 companies are legally headquartered in Delaware
Through its Delaware Block Initiative, launched in April by Gov. Jack Markell, the state plans to engage technology
vendors to help businesses and state agencies use blockchain technology to distribute, share, and save ledgers and
contracts
UNDP
•
•
The worldwide development network for the United Nations is pursuing a series of blockchain-focused projects
That work was quietly detailed in a United Nations Development Programme (UNDP) blog post, penned by members of the
Alternative Financing Lab
The lab said it was partnering with developers in Serbia and Moldova, among other regions, on blockchain projects, and
indicated that it planned to expand these efforts in the months ahead
Of particular interest, according to the post, is the use of Blockchain for exchanging funds
•
•
ECON
•
•
UK Gambling
Commission
•
•
European Parliament’s Committee on Economic and Monetary Affairs (ECON) has published a draft report on virtual
currencies, which amongst other things, contains a motion for a European Parliament resolution on virtual currencies
The report welcomes the European Commission’s proposals for including virtual currency exchange platforms in the
Fourth Anti-Money Laundering Directive
UK Gambling Commission has published a discussion paper looking at virtual currencies, alongside eSports and social
gaming, where it insisted that its recent move to classify cryptocurrencies as cash equivalents did not represent any
changed view
The Commission reiterated its view that any operator using cryptocurrencies must hold a UK operating license
© 2017 Deloitte Touche Tohmatsu India LLP
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Snapshot of Key Regulatory Guidelines (VCBA)
Purpose: The Uniform Regulation of Virtual-Currency Businesses Act (URVCBA) creates a statutory framework for
regulating virtual-currency business activity, which includes businesses engaged in the exchange of virtual currencies
for cash, bank deposits, or other virtual currencies; the transfer of virtual currency between customers; and certain
custodial or fiduciary services. The URVCBA also provides consumer protections and disclosures.
Benefits:
• Provides a clear scope
• “Regulatory on-ramp” encourages innovation
• Contains numerous consumer protections and product / services guidelines
• Reciprocal licensing provisions offer efficiency for businesses and the states
Applicability: 3 tier structured
Must register
Business activity between $5,000 to $35,000 annually
Must obtain a license
Business activity greater than $35,000 annually
Exempt from the act
Banks, Fintech (charters from the Office of the
Comptroller of the Currency)
© 2017 Deloitte Touche Tohmatsu India LLP
Key point to apply for License:
• a description of the applicant’s current business;
• a description of the applicant’s business for the previous
five years;
• a list of the money transmission licenses the applicant
holds in other states; and
• lawsuit and bankruptcy history of the applicant and the
applicant’s executive officers.
22
Trust Code for DarkNet is Permissioned
access… Regulations need to enforce the
same in the ecosystem
© 2017 Deloitte Touche Tohmatsu India LLP
23
BlockChain
Risk
Framework
© 2017 Deloitte Touche Tohmatsu India LLP
24
Risk Management Framework
BlockChain Risk Framework
BlockChain
Business
Objectives
Business Risk
BlockChain
Risk
Consideration
Growth/Innovation
Strategic
Client Experience
Financial
Cost Reduction
Improved Time to
Market
Operational
Risk & Compliance
Management
Technological
Regulatory
DLT Design &
Consensus Protocol
Cyber Security/
Privacy &
Confidentiality
DLT Network Legal
Considerations
DLT Capacity
Management
DLT Integration
and
Interoperability
Smart Contract
Definition &
Execution
DLT Network
Governance
DLT Network
Regulatory
Compliance
DLT Contingency
Planning
DLT Data
Management
Cyber Security Strategy
Secure
Deloitte Cyber
Security
Framework
Vigilant
1. Risk & Compliance
Management
5. App Security &
Secure SDLC
9. Vulnerability
Management
12. Cybersecurity
Operations
2. Identity & Access
Management
6. Asset Management
10. Threat Intelligence
13. Predictive Cyber
Analytics
3. Data Protection &
Management
7. Third Party Risk
Management
11. Security and Threat
Monitoring
14. Insider Threat
Monitoring
4. Infrastructure
Security
8. Physical Security
© 2017 Deloitte Touche Tohmatsu India LLP
Resilient
15. Crisis Management
16. Resiliency & Recovery
17. Cyber Simulations
18. Incident Response & Forensics
25
Understanding Risk Considerations
Risk category
Risk Description
1. DLT Design & Consensus
Protocol
•
•
2. Cyber Security, Privacy &
Confidentiality
•
•
•
3. DLT Network Governance
•
•
4. DLT Network Regulatory
Compliance
•
•
© 2017 Deloitte Touche Tohmatsu India LLP
Immutability – DLTs are inherently immutable. While this allows audit trail and peer to peer transfer
of value, it might be an impediment in certain enterprise solutions. Especially in the light of ‘Right to be
forgotten’ rule by certain regulators
Consensus Protocol - Each consensus protocol has its own pros and cons which need to be evaluated
in the context of the specific solutions
Lack of confidentiality of data means without adequate controls, all participants in a DLT network
can have access to confidential data as well as track transaction patterns, which can be used
by peers to gain competitive advantage
A DLT increases the number of entry points – Organization needs to take a layered approach to
developing security strategy
Quantum computing may also threaten the premise of asymmetric cryptography
Unlike traditional representative models of governance, where systems of checks and balance are
exercised through third parties, under bitcoin’s consensus model, accountability is distributed
directly and exercised by all in the network
DLT is susceptible to what is called a 51% attack, where joint or monopolistic forces could
manipulate certain information by controlling the majority of the network
The risks associated with the failure to meet regulatory obligations. This includes risks associated with
the failure to identify, communicate and comply with current and changing laws, regulations, rules,
regulatory guidance, self-regulatory organization standards and codes of conduct, including the prudent
risk management of Money Laundering, Terrorist Financing, Economic Sanctions and Bribery and
Corruption risk
Currently, there is significant uncertainty globally around the regulatory response to DLT applications.
Additionally there may be regulatory risks associated with each use-cases and players - depending
on domestic or cross-border. This could include cross-border regulations related to privacy and data
protection
26
Understanding Risk Considerations
Risk category
Risk Description
5. DLT Network Legal
Considerations
•
The risks associated with the failure to meet legal obligations from legislative or contractual
perspectives and the risk associated with failing to obtain and/or enforce contractual commitments
from 3rd parties
6. Smart Contract Definition &
Execution
•
Smart Contracts can potentially encode complex business, financial and legal arrangements on the
DLT, and could result in the risk associated with the one-to-one mapping of these arrangements from
the physical to the digital framework. Additionally, cyber security risks may increase, as the Smart
Contracts rely on outside oracles* to trigger the execution of the contracts
7. DLT Capacity Management
•
In the absence of capacity management the risk of not monitoring the threshold on the block size,
maximum size of standard transaction etc. can lead to various attacks.
Lack of monitoring the uptime and latency for other nodes in DLT.
•
8. DLT Contingency Planning
•
•
Identifying the concentration risk scenarios in the event that certain participant(s)/node(s) go
offline
The risk associated with not regularly testing and updating the business continuity plan with
relevant DLT vendors.
9. DLT Integration and
Interoperability
•
•
•
Risk associated with implementation and integration of DLT nodes
Lack of DLT technical knowledge to support the systems.
Risk associated to standardize requirements and harmonization of interoperability of different
distributed ledger protocols
10. DLT Data Management
•
Risk of storing data without classification and improper management can lead to loss of data to
unauthorized parties.
Improper segmentation of critical systems holding confidential data.
•
© 2017 Deloitte Touche Tohmatsu India LLP
27
Other Audit Considerations
The auditing requirements of the origin of the blockchain data, the
integrity of the transactional data and the need to ensure there is a lack
of material error from a business, technical and financial reporting
perspective mean that there will be a need for a broader group of
specialties within the audit team.
Auditors will need to formulate new rules to ensure safe and reliable DLT
activity. Rules relating to data and technological architecture for
organizations using DLTs will also need to be defined and agreed during
the design phase
An audit should also take into account any other facts and circumstances
necessary for the proper accounting treatment of transactions and factors
determining the fair market value of digital or physical assets.
It may be necessary to identify the connection between a blockchain
transaction and an additional off-chain transfer of funds related to this
blockchain transaction.
The auditing questions raised by the existence of this code on the
blockchain may include:
• Who approves changes to the shared codebase?
• How are access control lists within smart contracts administered?
© 2017 Deloitte Touche Tohmatsu India LLP
28
Summary
© 2017 Deloitte Touche Tohmatsu India LLP
29
Increasing adoption, among other factors,
would push up the perceived value of
crypto currencies. Regulatory requirements
would help stabilizing the value…
© 2017 Deloitte Touche Tohmatsu India LLP
30
Regulatory requirements should focus on
improving transparency and traceability,
protecting consumers, controlling
inflationary/ deflationary efforts, etc.
© 2017 Deloitte Touche Tohmatsu India LLP
31
Auditors would need to transform their
methods for performing financial audits…
© 2017 Deloitte Touche Tohmatsu India LLP
32
Questions?
© 2017 Deloitte Touche Tohmatsu India LLP
33
Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee
(“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally
separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to
clients. Please see www.deloitte.com/about for a more detailed description of DTTL and its member firms.
The information contained in this material is meant for internal purposes and use only among personnel of
Deloitte Touche Tohmatsu Limited, its member firms, and their related entities (collectively, the “Deloitte
Network”). The recipient is strictly prohibited from further circulation of this material. Any breach of this
requirement may invite disciplinary action (which may include dismissal) and/or prosecution. None of the Deloitte
Network shall be responsible for any loss whatsoever sustained by any person who relies on this material.
©2017 Deloitte Touche Tohmatsu India LLP. Member of Deloitte Touche Tohmatsu Limited
How does a Bitcoin transaction work?
Source: IEEE Website:
http://spectrum.ieee.org/static/future-of-money
© 2017 Deloitte Touche Tohmatsu India LLP
35
Illustrative list of players in the ecosystem
Category
Description
Some examples of companies operating in each space
Bitcoin exchanges
Platforms where users buy and sell Bitcoins into other
currencies
BitStamp, CoinSpot
Bitcoin wallets
Digital place for consumers to safely store Bitcoins
CoinBase, BitGo, CryoBit
Bitcoin payment providers
Parties that facilitate payments in Bitcoins
BitPay, GoCoin, Circle
Bitcoin ATMs
Companies that provide physical machines to allow traditional
currency conversion to Bitcoins
Lamassu, Robocoin, Skyhook, BitAccess
Bitcoin mining equipment providers
Companies that sell processors specially designed for Bitcoin
mining
BitFury, KcNMiner, Butterfly Labs, Bitcoinminerz
Bitcoin verification services
Companies that provide identity verification services
Bonafide, Jumio
Bitcoin focused consulting services
Service providers for operations, tax and compliance for
Bitcoin businesses
LibraTax, XenAccounting, CoinComply, Koffler Legal and Consulting
services
Bitcoin financial services
Companies that provide Bitcoin services such as loans,
remittances, and investments
Vaurum, BitLendingClub, CoinFinance
Bitcoin analytics services
Companies that analyze Bitcoin block chain data for insights
Coinalytics, BitsofProof
Bitcoin recruitment agencies
Companies that connect Bitcoin specialists to relevant jobs
Honey Badgr, Bit Recruiter, Coinality
Bitcoin wage-processors
Companies that process Bitcoin compensation for individuals
BitWage, WagePoint
Bitcoin advocacy groups and funds
Companies that prorogate the use of Bitcoins and create large
funds to invest in Bitcoins or the ecosystem
Bitcoin Foundation, Plug and Play
Bitcoin specific online media
Organizations that aggregate real-time Bitcoin news and track
Bitcoin price
CoinDesk, CoinTelegraph, Bitcoin Magazine
List of companies accepting Bitcoins
NA
Click here
List of Deloitte clients accepting Bitcoins
NA
Dell, Expedia, PayPal
© 2017 Deloitte Touche Tohmatsu India LLP
36
Tracking regulatory uncertainties that hamper Bitcoin adoption
LEGAL STATUS OF BITCOINS ACROSS THE GLOBE
KEY U.S. REGULATORY DEVELOPMENTS
Date
Mar 2014
Jul 2014
•
In developed countries such as the U.S. and Canada the
regulatory landscape is dynamically changing with policy makers
recognizing the need to both support and regulate Bitcoins
•
Bitcoin’s legal status in several emerging nations in Africa is
contentious as regulators are still debating the use of Bitcoins as
a currency
•
Nations such as Iceland and Vietnam have declared Bitcoins as
illegal, while Russia & China are enabling legal infrastructure to
limit the use of Bitcoins
Source : Where is Bitcoin legal?, CNN Money Is Bitcoin legal?, Coindesk.com
© 2017 Deloitte Touche Tohmatsu India LLP
Story
Impact on Bitcoin ecosystem
Internal Revenue Services (IRS)
declared that it would treat Bitcoin as a
property and not currency for tax
purposes
•
New York State Department of
Financial Services (DFS) proposed
regulations around licensing of virtual
currency businesses through BitLicense
•
•
•
Dampened Bitcoin investors as upside
opportunities are restricted
VCs, start-ups, and banks welcomed this as
it minimized impact of regulatory uncertainty
BitLicense will aim to protect consumer
interests in the future
BitLicense will provide for rigid frameworks
and guidelines for companies that hold
customer assets
Aug 2014
The Consumer Financial Protection
•
Bureau (CFPB) stated that Bitcoins are a
risky “Wild West” in the financial markets. It
also started accepting consumer complaints
tied to virtual currencies
The CFPB has signaled its active interest in
solving consumer grievances thus paving the
way for more consumer interest and investor
confidence
Oct 2014
Financial Crimes Enforcement
Network (FinCEN) issued rulings for
companies operating in the Bitcoin
economy to be considered as money
service businesses for purpose of the
Bank Secrecy Act (BSA)
•
This will regulate start-ups and players in the
Bitcoin eco-system
It will also protect interest of Bitcoin investors
as money service businesses have to register
with FinCEN, adopt anti-money laundering
policies satisfying the requirements of the BSA,
and apply for licenses in states they operate
The Commodity Futures Trading
Commission (CFTC) Commissioner
Mark Wetjen supported acceleration of
policymaking and regulation for virtual
currencies such as Bitcoin
•
Nov 2014
•
•
CFTC did not announce any actual
regulations around Bitcoin driven
investments
This increased the lack of regulatory clarity
around investing in Bitcoins
37
Identifying disruptive applications of Bitcoin
IMAGINE A WORLD WHERE…
SOME DISRUPTIVE APPLICATIONS OF BITCOINS AND BITCOIN TECHNOLOGY
You could pay a penny for an
article without subscribing to
the entire magazine
BITCOINS CAN MAKE MICROPAYMENTS POSSIBLE
Using Bitcoins, users can directly pay musicians for their songs or tip on social media platforms. As per Time
Inc., micropayments can be leveraged by online content providers to increase revenues through pay per
article model. Recently, Time and Coinbase joined hands to enable Time to accept Bitcoin payments for its
publications.
You could transfer your
salary to another country
with zero costs
BITCOINS CAN DISRUPT CROSS-BORDER PAYMENTS & REMITTANCES
Bitcoin payment networks can transform international money transfers by reducing costs for customers and
reducing fees, large collaterals, and intermediation from large banks for smaller banks. Companies such as
Ripple Labs are developing systems to facilitate instant international payments in Bitcoins. It is expected
that smaller banks will adopt this model and change traditional international remittance market.
You earn a virtual salary and
pay your loans virtually
BITCOINS CAN SHAPE INNOVATIVE COMPENSATION MODELS
Companies such as Structur3D printing are adopting innovative payroll options such as Bitcoin
compensations to retain technical talent. Various Bitcoin wage processors such as BitWage and WagePoint
are offering similar services. Additionally, Deloitte recently published an article around this theme which is
expected to become mainstream once the Bitcoin ecosystem stabilizes.
You could buy a house
without involving multiaple
lawyers and escrow agents
BITCOIN TECHNOLOGY CAN REVOLUTIONIZE SERVICES AROUND COMPLEX ASSET TRANSFERS
Currently transfer of property requires multiple third parties such as real estate agencies, lawyers, and
notaries to process one deal. Organizations such as ColoredCoin are developing technologies that use
Bitcoins to represent physical assets. This would enable the buyers to view past records of ownership and
history about the property including insurance claims, damages, repairs before the purchase.
You could travel the world
without a passport using a
unique code
BITCOIN TECHNOLOGY HAS THE POTENTIAL TO TRANSFORM IDENTITY MANAGEMENT SYSTEMS
Bitcoin technology can be used to create secure, private identity keys to verify identities or track movement
across borders. This can replace the need for personal ID document such as driver’s license and social
security numbers. While Deloitte and other advocacy groups support this move, strong government backing
will be needed.
© 2017 Deloitte Touche Tohmatsu India LLP
Legend for imminence
Immediate impact
Gradual impact
Distant possibilities
IMMINENCE
Impact of the application/ trend
based on market activity
38
How does a Bitcoin transaction work?
Barriers to Implementation
Challenges related to integration and adoption need to be addressed to realize potential of blockchain efficiencies
Challenge
Market
adoption
Evolving
Technology
Integration with
legacy systems
and processes
Contract
flexibility
Legal and
regulatory
requirements
Description
Potential Mitigation
•
A critical mass of individuals and organizations would need to
participate in Blockchain or specific sidechain, to entice enough
activity to make it viable for transactions.
•
Higher traction in adoption of this use
case by big firms and individual
investors.
•
Blockchain as technology is still maturing and various platforms and
applications are still evolving. A global standard still does not exist.
•
Build with microservices so your
solutions are portables
•
To realize full potential of operational benefits that Blockchain can
offer, it must function in close collaboration with other peripheral
systems.
•
Programming a smart contract requires a determination of the
execution of events during the life of an investment reduces
flexibility unless provisions for an amendment were incorporated.
•
Pre-Programed resource mechanisms,
to allow for amendments.
•
Legal recognition of programmable contracts and digitally
transferred assets in the court of law ;lack of regulatory bodies.
•
Involving legal stakeholders and identifying
and working with appropriate regulatory
bodies from early stages.
© 2017 Deloitte Touche Tohmatsu India LLP
•
Blockchain infrastructure that
supports smooth linkage between
multiple applications
39
The DAO Illustrates Some of Blockchain’s Challenges
D
What is a DAO?
A “ Decentralized Autonomous organization” with goal of creating lean governing structure for Blockchain network
(similar to market index) . Bitcoin was the first DAO, governed by it’s users.
The DAO, launched in April 2016 on the etherum network, enabled users to exchange ether for voting tokens to
determine how the DAO would use raised funds. The largest crowd-funding projects –to-date, the DAO raised $ 150
M in ether (etherum value token) and was hacked in June due to gap in code.
The DAO Hack
In June 2016 a hacker took advantage of bug in DAO, moving
3.6 MM ether into a “child DAO”, inaccessible to token-holders.
The hack was wild according to smart contract terms.
Soft- and hard fork solutions were proposed to either block the
account from further transactions (soft-fork) or return the ether
to the rightful owners (hard-fork).The etherum community
voted hard-fork fix , which created copy of the Blockchain and
returned to the block before the hack – as if the hack never
happened. This has split the community two etherum and
etherum classic .
© 2017 Deloitte Touche Tohmatsu India LLP
Takeaway
•
Block chain, like any technology, is :
- A likely target for hacking
- Susceptible to human error (e.g. –gaps in code)
•
Hacking reveals the potential for challenges around
the immutability of the Blockchain –once transactions
are recorded , the can not be reversed.
40