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The UK government should think twice about allowing payments in crypto-currencies such as bitcoin, given uncertainty over their legal and accounting status, regulation and potential economic impact, argues Robert Lyddon from IBOS.

Bitcoin and other crypto-currencies (secret currencies) are getting a lot of airtime and being considered with seriousness, for example at the UK Treasury, for inclusion in or coalescence with the traditional payments ecosystem.

At this stage there are more questions than answers, and this should be concerning for market participants and regulators. The Financial Action Task Force, in its June paper on definitions and anti-money laundering risks, and the European Banking Authority, in its July ‘Opinion on virtual currencies’, have made their positions clear: crypto-currencies have no validity and are a channel for money laundering, illicit financing and tax evasion.

Nevertheless the UK Treasury is studying crypto-currencies, the Financial Conduct Authority has established an Incubator Hub to support innovation in financial services, and the Payment Systems Regulator has issued a “new regulatory framework for payment systems in the UK” in which a prime objective is “to promote…innovation in payment systems”.

These initiatives lend crypto-currencies an inferred legitimacy that belies the lack of answers in key areas. Here are a series of questions that risk professionals in banks and financial institutions need to ask themselves when evaluating the effect of bitcoin on their business.

Legal standing

Crypto-currency cannot be ‘money’ in the accepted sense. It is not a fiat currency issued by a national government and backed by the full faith and credit of its taxpayers. It cannot be legal tender as its designation is another power reserved to national governments or associations of national governments (in the case of the euro).

It is ‘mined’ (i.e. manufactured) via computer algorithms and the difficulty of mining is supposed to limit supply, and where there is limited supply and significant demand, the price should go up.

The US Department of Justice has designated it as ‘goods’. If that treatment is replicated in the UK and the rest of the EU, then all exchanges involving bitcoins are sales by the giver and purchases by the receiver, in other words a barter trade.

Accounting and tax status

As regards accounting, should payments made with bitcoin be added to cost of goods sold, and payments received added to sales? In other words, if, as a business, you buy something and pay for it with goods, the goods you use as payment have to go through the books as a sale of goods themselves; that could get very messy.

If you pay with bitcoin but receive real money, do you inflate your profits and pay more corporation tax? Alternatively, if you receive bitcoin and pay out in real money, can you eliminate your profit and your corporation tax liability?

bitcoin2-5Are crypto-currencies subject to the VAT regime, including – for businesses – adding VAT to a bitcoin payment if you are VAT-registered?

Since bitcoin is secret, do you even know who you are trading with, what VAT should be added and what you should put in your EC sales list?

What about the valuation of bitcoin owned if it rises or falls? Are such profits taxable and any losses tax-deductible?

Consumer protection

What does an ‘owner’ of bitcoin own actually – an investment or an account balance?
If it is an investment, should a promoter in the UK be registered with the Financial Conduct Authority? If it is an account, is there recourse to a taxpayer-funded lifeboat fund if a bitcoin ‘deposit’ goes bad or disappears?

Who is behind a crypto-currency? Bitcoin has to be purchased with real money but who is accountable if the crypto-currency is not delivered? What about transparency of pricing?

Fiscal and monetary impact

If economic activity does start to be conducted using bitcoin out in the ether, and such inconveniences as online pay-as-you-earn filings and EC sales lists can be circumvented, that can leave a hole in national revenue accounts.

There are also monetary policy ramifications. If there is any easy link between the bitcoin world and the fiat currency world, such that the creation of ‘money’ in the crypto-world creates money in the real world too, how does that affect any attempts by central banks to manage money supply? Are crypto-currencies a sort of private and uncontrolled quantitative easing? What could be the ramifications for prices of assets, pensions, investments and so on?

Regulatory responsibility

In the UK, we now have multiple financial regulators: the Financial Conduct Authority, the Prudential Regulation Authority, the Bank of England’s Financial Policy Committee, the Payment Systems Regulator, the Treasury and the Financial Ombudsman. Crypto-currencies fall easily within the remit of none of them, increasing the chance that problems will slip between the cracks again, the way they did in the run-up to the 2008 crisis.

There is a certain head of steam building around crypto-currencies and a corresponding dearth of both education for buyers and position-taking by authorities – a potentially dangerous combination for those who have money from which they might become parted. But the UK authorities have convinced themselves that the UK should become a financial technology capital and crypto-currencies are an example of ‘fintech’, so what’s not to like?

Robert Lyddon is the General Secretary of international banking network IBOS

Read the full article here.