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A quick lesson on blockchain for accountants: Part 2 – mining cryptocurrency

downloadIn Part 1 two weeks ago, I wrote about currency. Here, I’ll explain how “miners” help a cryptocurrency like bitcoin be useable.

To be honest, I had no idea until recently what bitcoin mining actually means – and remember bitcoin is just one cryptocurrency, but I will use it here as an example.

Some weeks ago, I visited a friend of mine who owns and runs a technology maintenance firm. His office is always full of various parts of computers, but on this visit I noticed the office was quite warm and there was a hum of computer fans. So, I stuck my head around a corner and I seen something like what is in the picture above. So, joking I said, “what are you at now, mining bitcoin?”. “Yep” was the reply. So I took the opportunity to lean on my friend for some explanations.

The bottom line for me as an accountant, is that a “bit-coin mining rig” like that in the photo costs about €3,000 and can earn about €500 per month before energy costs – I will come back to these costs in a later post. So what the hell is it and what does it do I hear you ask? In my previous post, I established that bitcoin is not really a currency (yet) in the sense of dollars, euro or pounds. It also does not have a central bank behind it, or commercial banks taking it on board as a major currency. So this creates a problem, which in essence is if I want to pay you one bitcoin, how is this to be done – and remember bitcoin is an electronic medium, there are no paper notes.

Well, if I were to pay for a coffee with my credit/debit card, there is an extensive payments processing system behind the payment – think of the credit card machine, Visa/Mastercard/Amex systems and ultimately the retailer’s bank. Also, you may know that for every card transaction, the retailer is charged by the bank so they never get the full value of a card sale. For a bitcoin payment, where is the system? This is where the “miners” come in.  A miner is someone who essentially processes bitcoin payments. My friend mentioned above told me the steps roughly are as follows:

  1. you get a rig (like the picture above). The faster the better, so rigs tend to use the fastest available memory cards – think about the graphics in a gaming console – these use really fast memory.
  2. Join a mining community
  3. Start solving hashes (encryption puzzles)- that is, process and verify bitcoin transactions. This includes working with blockchain, which will be explained in an upcoming post.
  4. Get a commission for each transaction
  5. Transfer the commission to a bitcoin wallet – for example, the Coinbase app
  6. Transfer to your bank account as you see fit.

So, in essence, a bitcoin miner like my friend is taking the place of the commercial banks and/or credit companies and processing payments. It is basically a form of distributed computing.

So from an accounting perspective what does this mean? Well, not very much actually. But, and this is a big but, would/could we trust people like my friend to effectively become a banking system. Personally, I am not sure. We have decades of regulation around our banking systems, and even with all the oversight, it still fails from time to time. The counter-argument could be something like the redundancy of systems or devolvement of the now rather central power of the banking and finance systems. But I’m not so sure just yet.

My next post will explain the basics of encryption.

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A quick lesson on blockchain for accountants: Part 1 – currency

downloadI have been meaning to write something on blockchain for quite a while now. So, in this post and the next few, I will write what I hope are some simple lessons which will give you an appreciation of blockchain. To do this, I want to go back to some basics first and here I will remind you what a currency is. For these posts, I will use the example of a blockchain being used in cryptocurrencies, but there may be many other uses as time goes on.

So what is a currency? We probably all think we know what it is, it is the money in our pockets. That is a fair starting point, but we need to big a little deeper.  In accounting – see for example the IASB’s Conceptual framework – there are several measurement bases: current cost, historic cost, present value, realisable value. The conceptual framework of the IASB defines measurement “as the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement”.  Monetary means in money, and money can be defined as a current medium of exchange – hence the word currency.  So, for accounting, this means we measure assets, liabilities, incomes and expenses in currency – a dollar, a euro, a pound.  So why not in bitcoin, or litecoin or ethereum? Are these not currencies?

To answer these questions, let me divulge for a moment. When I was in secondary school, I studied “Business Studies”. From this, I remember something which used to be printed on all the Irish pound notes before we had the Euro, the term legal tender. I also recalled that all pound notes were legal tender, and a certain amount of coinage. Legal tender means that the currency is acceptable as a means of settling a debt. In Irish law, before the introduction of the Euro, a 1969 law set out that all notes and some coinage were legal tender e.g. a debt of £20 could be paid in coins of 10 pence or greater. The concept still applies to the Euro notes, and in other currencies too. However, being legal tender only means something is an acceptable means of payment, it does not have to be accepted in general.  Thus, cheques, credit cards, PayPal, ApplePay, and guess what you got it, cryptocurrencies, do not have to be accepted as a form of payment. Having said that, typically banknotes are issued by a country’s central bank and are nearly always accepted.

So, if something is not legal tender, then there is a chance they may not be accepted as a method of payment (i.e. settlement of a debt). At this stage you are thinking, but if credit cards etc are not legal tender why are they so widely accepted? The answer lies in the fact that the banks who issue the cards and process payments are doing so typically in a currency recognised as legal tender.

Let me pose a question now. If you went to a typical shop in a town or city, and you had some cryptocurrency, maybe bitcoin, in an electronic wallet would you be able to pay for a coffee? The answer is generally no, but there are some online and other retailers who will accept payment in bitcoin. So it is probably fair to say that as bitcoin is not generally accepted (yet), it is not a currency. And, as far as I am aware, no cryptocurrency is yet legal tender. For accountants, this means that we are not yet measuring in cryptocurrency, and no accounting reports will be prepared in bitcoin for example. Thus in accounting terms, any cryptocurrency a business may have is treated as an asset in the financial statements – typically a current asset, like a normal bank or cash account. Of course, cryptocurrency values seem to be rather unstable, but this is not something I cover here.

Now that you know what a currency is, Part 2 of this series of posts will explore how bitcoin payments are processed.

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