Crypto currencies and regulations by the tech start up channel show

Cryptocurrencies & Regulation November 2017

“Distributed Ledger Technology” is the technology behind BlockChain

BlockChain lends itself to multiple usecases – One of which is Crypto Currency

BitCoin is one among a larger number of Crypto Currencies. Other examples would be Ethereum, Ripple, LiteCoin, Monero, Dash, Augur…

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 5

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

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Russia Has Found Best Location for Crypto Miners

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Singaporean Mining.sg Reports Increasing Hardware Demand

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Iranian Government Preparing for Bitcoin Use Inside the Country

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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

Agenda

1. Crypto Currencies & EcoSystem 2. Market & Regulatory Landscape

3. Risk Framework on BlockChain

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

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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

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 •

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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

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

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

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.

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

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”

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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.

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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.

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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.

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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.

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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.

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

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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

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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

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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

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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

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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

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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

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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

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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

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Demand for crypto currency specialists i.e. web/mobile developers and engineers with domain knowledge has resulted in companies such as Coinality coming up

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

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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

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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

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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

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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

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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

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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

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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

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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

Market & Regulatory Environment

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.

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

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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

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Regulators proposed handling virtual currencies as methods of payment equivalent to conventional currencies. Government officially recognized Bitcoin as a method of payment.

China

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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.

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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

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Bitcoin is not banned Authority has warned of using it, as it is a high risk asset

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The European Commission is currently conducting a risk assessment on terrorist financing and money laundering, paying particular attention to virtual currencies.

Malaysia

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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.

Financial regulators seem generally excited by the positives of Blockchain, but there are still concerns over illicit activity Regulator

Summary

FCA

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FCA launched Project Innovate to help businesses deal with the regulatory hurdles to launching new financial products, including Blockchain securities

OCC

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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

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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

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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

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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

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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

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Security regulators have taken a mixed stance on how Blockchain technology should be viewed and regulated Regulator

Summary

SEC

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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

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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

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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

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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

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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

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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

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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

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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

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Bank of Russia

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The Dutch Bank

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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

Entities outside the world of financial regulation have also begun to explore how they can leverage Blockchain technology Entity

Summary

State of Delaware

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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

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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

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UK Gambling Commission

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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

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 accessâ&#x20AC;Ś Regulations need to enforce the same in the ecosystem

ÂŠ 2017 Deloitte Touche Tohmatsu India LLP

BlockChain Risk Framework

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

ÂŠ 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

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2. Cyber Security, Privacy & Confidentiality

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3. DLT Network Governance

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4. DLT Network Regulatory Compliance

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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

Understanding Risk Considerations Risk category

Risk Description

5. DLT Network Legal Considerations

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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

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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

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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.

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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: â&#x20AC;˘ Who approves changes to the shared codebase? â&#x20AC;˘ How are access control lists within smart contracts administered?

ÂŠ 2017 Deloitte Touche Tohmatsu India LLP

Summary

Increasing adoption, among other factors, would push up the perceived value of crypto currencies. Regulatory requirements would help stabilizing the valueâ&#x20AC;Ś

ÂŠ 2017 Deloitte Touche Tohmatsu India LLP

Regulatory requirements should focus on improving transparency and traceability, protecting consumers, controlling inflationary/ deflationary efforts, etc.

ÂŠ 2017 Deloitte Touche Tohmatsu India LLP

Auditors would need to transform their methods for performing financial auditsâ&#x20AC;Ś

ÂŠ 2017 Deloitte Touche Tohmatsu India LLP

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How does a Bitcoin transaction work?

Illustrative list of players in the ecosystem