First described in ‘Bitcoin: a peer-to-peer electronic cash system’ written by person or persons going under the pseudonym Satoshi Nakamoto, Bitcoin was defined as a means of trade that used a network of computers called the ‘distributed ledger’ to guarantee transactions by linking them ‘into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work’, and thereby avoiding the long-standing problem common to digital currencies of ‘double spending’.

The problem, according to the paper, was that until that point any proposed system of electronic currency ‘works well enough for most transactions, [but] still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes.’

The solution to this problem, called ‘blockchain’, has generated considerable interest from financial institutions and computer security experts. Companies as diverse as American Express, Oracle, Alibaba and Facebook have either expressed interest in implementing blockchain in their businesses or currently utilise it to secure data or financial assets.

The most visible use of blockchain is the cryptocurrency Bitcoin, which reached a trading price high of £15,520 in December 2017. However, fluctuations in price and the relatively labour-intensive process of transferring cash from one user to another have so far limited Bitcoin’s acceptance as a currency. At the same time, the number of cryptocurrency alternatives has increased, with Ether, Ripple and Litecoin also generating investor interest. Counterfeit versions and Ponzi schemes have also been reported.

Speculation on cryptocurrencies, and the potential risks to investors, led the Financial Conduct Authority (FCA) to issue a statement in April 2018 on the requirement for firms offering cryptocurrency derivatives to be authorised, stating that it was ‘aware of a growing number of UK firms offering so-called cryptocurrencies and cryptocurrency-related assets. As indicated in our feedback statement on distributed ledger technology (DLT), cryptocurrencies are not currently regulated by the FCA, provided they are not part of other regulated products or services.’

Cryptocurrencies in general pose a problem for accountants as they defy the strict definition of both cash in FRS 102 Financial Reporting Standard (‘cash on hand and demand deposits’) and cash equivalents (‘short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value’). However, the practical application of blockchain has not been overlooked, with several companies in the process of developing blockchain-based accounting systems that work by preserving small pieces of company information in order to create a verifiable series of records that can be used to audit a business.

Report by James Bunney