What is bitcoin

© 2016 Crowe Horwath International
VIRTUAL CURRENCIES - THREAT OR
OPPORTUNITY: A BITCOIN CASE STUDY
© 2016 Crowe Horwath International
David Cafferty
Director – Risk Consulting
October 2016

© 2016 Crowe Horwath International 22
What’s on Tap for this Session?
• Understanding virtual currencies and tackling
challenges such as customer anonymity
• Interpreting the FATF’s recommendations regarding
virtual currencies
• Assessing the environmental risks associated with
virtual currencies
• Applying lessons learned from recent enforcement
actions on alternative currency exchanges

Understanding Virtual Currencies

Virtual & Crypto Currencies
• Do you know what virtual currencies are?
• Are they something that you should be considering?
• When it comes to virtual currencies “are you in or out”?
• Are you aware of the risks / benefits of virtual
currencies?

• Financial Action Task Force (FATF): Virtual currency is
a digital representation of value that can be digitally
traded and functions as medium of exchange, and / or
a unit of account, and / or a store of value but does not
have legal tender status in any jurisdiction.
(FATF Report: Virtual Currencies: Key Definitions and Potential AML / CFT Risks (June 2014))
• It is however regulated in some countries and under
consideration by many others.
• Other definitions of virtual currencies exist including – digital
currencies and peer-to-peer payment systems

• Virtual currencies can be “convertible / open”, which means that they
have an equivalent value in real money and as a result they can be
changed for real money, or
• Virtual currencies can be non-convertible or closed, which are specific
to online activity and cannot be converted to real money
• Virtual currencies can also be centralised with a single, administrative
authority or de-centralised, which are open-source, peer-to-peer virtual
currencies with no central administration authorities
• Decentralised virtual currencies are frequently know as “crypto
currencies” and as such are maths-based currencies that are protected
by cryptography
• The best known, and most commonly used decentralised virtual
currency is “Bitcoin”

Virtual Currency Types
Centralized
• Single Admin
• Central
Repository
• “Closed”
Decentralized
• No Single Admin
• No Central
Repository
• “Open”

Decentralized Exchange

BTC Only - Transmission: Peer-to-Peer

$-BTC-$: Transmission & Exchange

Understanding the BitCoin Ecosystem

The Ecosystem
Wallets
ATMs
Processors
Exchanges
Miners
Users

The Ecosystem
• Mining – this is the way that BitCoins are created –
• Every ten minutes (average) Miners try to solve a proof of work
problem (a hash) / (algorithm)
• The first one to solve the problem publishes a “block” on the
Blockchain, that includes all transactions for the last ten minutes
• The reward for solving a block is 12.5 bitcoins
• With constant halving there will eventually only be 21 million bitcoins
• Miners also get transaction fees
• Requires specialist hardware
• High upfront investment
• Incredibly competitive
• The computing power of miners is greater than most supercomputers

The Ecosystem

BitCoin Wallets
• The term Bitcoin wallet refers to a file that contains the number or numbers of
accounts that hold money
• There is also wallet software for managing accounts and transactions
• Since Bitcoins are valuable, wallets should be encrypted
• The secret numbers can be printed, generally as a barcode
• Printed Bitcoin values may be
• Locked up for security’s sake
• Held as a backup to an electronic wallet
• Used as paper money
The Ecosystem

The Ecosystem

Global ATM Market

BitCoin 2.0 – the Blockchain

Bitcoin 2.0?
• Welcome to Blockchain!
• Underlying technology supporting Bitcoin has other / future uses
Blockchain business use it in ways not previously envisaged
• In Bitcoin – used to store financial transactions
• Blockchain businesses – using it for much more
• In Bitcoin – the Blockchain is more like a ledger
• Blockchain is an ever-expanding computer file split up and distributed
to computers all over the world
• Each computer competes to add the next block to the Blockchain
• Cryptography ensures that the data cannot be altered without
invalidating every other entry in the Blockchain

• This in turn makes each entry in the Blockchain immutable (cannot be
• changed)
• The uncoordinated nature of the network keeps it honest!
• To corrupt / hack the system you would need to commandeer more
than 50% of the computers on the system
• Review at www.blockexplorer.com
• Problems include -• Scale – current estimate is 36GB
• Known as “Blockchain Bloat” and currently being studied
• What can Blockchain be used for?
• Any transactional data that requires immutability
• Think Land Titles
• Governments trying to prevent title fraud
Virtual & Crypto Currency

• Other opportunities include –
• Contracts
• Royalty payments
• Authentication certificates
• Government budgets?
• Other characteristics include –
• No central controlling authority
• By-passes single points of failure (banks / land registries)
• Transparency International generally supportive as protection
against monopoly abuse / more opaque
• Future risks –
• Blockchain’s strength / weakness is its distribution
• Currently there is no technical capability to manipulate the blocks
• But is it future proof?

Regulatory Framework

• Commercial Usage
• Small as predominantly used for speculative purposes
• Increasing growth because of lower transaction fees
• Increasing adoption for business use
• 1000 offline / 35000 online
• Capitalisation reached US$ 10 billion in 2013
• Current Concerns include -
• Theft
• Volatility
• Exchange failures
• Technical problems
• Regulatory interest
• Money Laundering concerns (Silk Road)
• Legal status

• Bitcoin is hard to regulate because it is: -
• Decentralised
• Global
• Flexible
• Popular
Regulatory Framework

Early
Adoption/
Minimal
Regulation
Increased
Adoption/
Increased
Regulation
Mainstream
Adoption/
Enhanced
Regulation
Virtual Currency Adoption & Regulation

Virtual Currency Adoption & Regulation

Examples of Global ‘Regulation’ of Virtual
Currencies
• U.S. FinCEN Interpretative Guidance (March 2013)
• Japan Payment Services Act - regulating virtual currency (2016)
• Canada Bill C-31 (Feb 2014)
• FATF Virtual Currencies Key Definitions and Potential AML/CFT
Risks (June 2014)
• Organisation for Economic Co-Operation and Development
“The Bitcoin Question: Currency vs. Trust-less Transfer
Technology (June 2014)
• European Banking Authority Opinion on ‘virtual currencies’ (July
2014)
• EU 4th Anti-Money Laundering Directive – amended to
encompass virtual currencies (2016)
• Currently under review in 63 countries (2016)

Regulatory Concerns
BTC bought and sold on internet exchanges but as most
buyers have to pay for BTC in hard currency, banks and
payment processors are the usual entry points for trade
in virtual currencies, which is why the FATF and banking
regulators are interested because of the perceived risk of
their misuse for money laundering and terrorist financing
purposes.

Virtual Currency Enforcement Actions

Enforcement Actions
Narcotics
• Silk Road (US) – “the Amazon.com of illegal drugs”
• A black market website that began on the TOR network starting in
February of 2011
• Relied upon anonymity
• Marketplace for illegal drugs and other services
• Bitcoin predates Silk Road
• Transactions are paid for with Bitcoin
• Uses an escrow system to reduce abuse
• Looks like eBay, but most things are illegal—most notably, drugs
• Shut down by the FBI on 10/2/2013 and leader was arrested
• Many millions of dollars worth of BTC were confiscated from people
all over the world, even if they broke no laws (US$ 100 million)
• Main Operator sentenced to life imprisonment without parole

Enforcement Actions

Fraud
• Mt Gox Exchange (Japan) – “the worst of both worlds”
• Operated like a traditional forex platform
• 70% of world Bitcoin trade
• Handled millions of dollars worth of bitcoin transaction a day
• 2013 Licensed (MSB) by FinCen
• Transactions were irreversible
• US$ 450 million went missing
• Mt Gox filed for bankruptcy
• Legal system unprepared for providing relief
• Hacking partly to blame
• Civil claims / lawsuits also ongoing
• US and Japanese investigations ongoing (2016)
Enforcement Actions

Enforcement Actions

Money Laundering
• Liberty Reserve (Costa Rica) – “oldest, safest and most popular
payment processor …”
• Centralised Digital Currency Service
• Liberty Reserve Dollars / Euros
• Over one million users
• No verification of identity
• Allowed third-party deposits
• May 2013: Shut down by US federal prosecutors under Patriot Act
• IRS “if Al Capone was alive today, this is how he would be hiding his
money”
• Investigations in 17 countries
• Laundered funds estimated at US$ 6 billion
Enforcement Actions

Enforcement Actions

The Future

• BTC usage
• Can be used to buy a beer in Berlin and London
• Can be used to buy a pizza in Amsterdam
• Can be used to hire a taxi in Edinburgh
• Can be used to book a hotel through Expedia
• Can be used to pay for a dental check-up in Ljublijana
• Can be used to buy socks in Massachusetts
• Can be used to book a space flight with Virgin Atlantic
• But beware – bitcoin will be taxed in Australia!

Next steps – a Virtual Bank?
• Virtual banks have been successfully launched in Europe and are
being considered in the other regions
• exist only online and as a digital credit provider
• can offer some or all of the same types of accounts as traditional
banks
• enter the market charging lower fees and pay higher interest
because of lower overheads
• are seen as providing a technological edge to customers by
allowing real-time transactions
• have no ATMs so deposits / withdrawals are made electronically or
by e-mail

• reimburse ATM fees charged by other banks
• appeal more to the young and technologically savvy as transactions
can be conducted via smart phones, computers or home telephones
• offer 24 / 7 service and live customer support
• appeal to larger techno-savvy companies
• do not have the legacy costs of “older” financial institutions and are
seen as more convenient
• are targeting the “unbanked” market
• can be more flexible
• can “white-label” technical systems with no capital outlay
• Examples include: Metro (UK); Ally (US); and Simple (Spain)
• Why not MENA?

Key Takeaways
• Understand the basics, begin to learn the
fundamentals
• Crypto-currencies move funds globally
• Very early stage development and market adoption
• Existing regulatory framework may be stressed
if/when increased adoption occurs
• Key risks continue to be price volatility, cyber security,
pseudonymity, and early-stage financial services
companies

Further Research

Crowe Horwath International is a leading international network of separate and independent accounting and consulting firms that may be licensed to use "Crowe," "Crowe Horwath" or "Horwath" in connection with the provision of accounting, auditing, tax, consulting or other professional services
to their clients. Crowe Horwath International itself is a nonpracticing entity and does not provide professional services in its own right. Neither Crowe Horwath International nor any member is liable or responsible for the professional services performed by any other member.
© 2016 Crowe Horwath International.
Questions

Crowe Horwath International is a leading international network of separate and independent accounting and consulting firms that may be licensed to use "Crowe," "Crowe Horwath" or "Horwath" in connection with the provision of accounting, auditing, tax, consulting or other professional services
to their clients. Crowe Horwath International itself is a nonpracticing entity and does not provide professional services in its own right. Neither Crowe Horwath International nor any member is liable or responsible for the professional services performed by any other member.
© 2016 Crowe Horwath International.
David Cafferty
+971 50 100 8558
david.cafferty@crowehorwath.ae
Thank you

Contact Details

For more information, contact:
David Cafferty
+971 4 325 9900
+971 50 100 8558
david.cafferty@crowehorwath.ae

About Crowe Horwath International
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