Blockchain 101. Featuring: MNP & The CSE Date: December 4, 2018

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1 Blockchain 101 Featuring: MNP & The CSE Date: December 4, 2018

2 Presenters Maruf Raza, CPA, CA National Director of Public Companies George Huang, CPA, CA Senior Manager, Public Companies Richard Carleton CEO Page 2 Slide Page #

3 Agenda Welcome and Introductions Part One: Blockchain 101 Part Two: CSE Token Platform Questions Closing Remarks Page 3 Slide Page #

4 Blockchain 101 Maruf Raza CPA, CA George Huang CPA, CA

5 BITCOIN =/= BLOCKCHAIN, HOWEVER Page 5

6 Agenda of this presentation What is Blockchain? What is Cryptocurrency, tokens, SAFT/ICO contracts? Accounting treatment for digital assets and revenue Audit risks for digital assets Crypto mining and crypto mining machines Impairment testing for crypto mining machines Page 6

7 Overview of Blockchain Page 7

8 Overview of Blockchain A public digital ledger Captures transactions Between parties in a network Internet-based Peer-to-peer A decentralized ledger there is no single point where decisions are made A distributed ledger Includes all transactions since date of creation Transactions are secured by public-key encryption Systems use a consensus algorithm Page 8

9 The Block and the Chain Page 9

10 Example Bitcoin Public/Private Key Type Key Length Private L1NheL9TWaSAdnxCk6y9uVGNrEaS7v7hNXbxytsfuCkvgfTC8rWL 52 Public 17tQEHFj9CcJuKBRoZKKT2GdbDhcgkP27n 34 Hash (SHA-256) Page 10

11 Wallet A Collection of Key Pairs You lose the private key, you lose the Bitcoin!!! Page 11

12 What Are Cryptocurrencies? In March 2018, the word "cryptocurrency" was added to the Merriam-Webster Dictionary any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions A type of digital asset that exists only on networks - not in physical form Cryptography is used in the generation, storing, transmittal and verification of transactions of these digital assets Page 12

13 What Are Cryptocurrencies? Examples of Blockchain Network: Bitcoin peer to peer electronic cash system - Bitcoin is the crypto currency on the network Ethereum transaction, DAPP, Smart Contract - Ether is the crypto currency on the network - Many ERC20 Tokens Total amount that may be in circulation is limited Total bitcoin market cap US$75 billion (at Nov 29, 2018) Approximately 1,500 different types of cryptocurrencies in existence Page 13

14 Coins Coins are cryptocurrencies operate on their own blockchains Page 14

15 Tokens Tokens are used to interact with decentralized applications that are built on top of different blockchains. Page 15

16 Other Uses ICO Page 16

17 What is an ICO/ITO/SAFT? Initial Coin Offering ( ICO) or Initial Token Offering ( ITO ) can be very similar to an Initial Public Offering ( IPO ) the public can purchase Tokens/Coins prior their release to crypto exchanges Simple Agreement for Future Tokens ( SAFT ) can be viewed the same as Simple Agreement for Future Equity ( SAFE ). Which are used frequently for institutional investors Similar to traditional shares of a company because their value may increase or decrease depending on the success of the business Capital is usually raised before a project commences and the project is then built on the amount of capital raised Page 17

18 Is a Coin/Token a Security? The Canadian Securities Administrators released certain specific criteria to determine whether or not a coin/token will be considered a security. They are: Does an ICO/ITO consist of... an investment of money in a common enterprise with the expectation of profit to come significantly from the efforts of others Page 18

Understanding of Crypto Mining Block and block rewards Hashrate January 27, 2009 50 bitcoins Current

19 Understanding of Crypto Mining Block and block rewards Hashrate January 27, bitcoins Current rewards 12.5 bitcoins Next halfing expected in May 2020 (1 PH = 1,000 TH = 1,000,000 MH = 1,000,000,000 KH) Page 19

20 Mining difficulty Mining difficulty Bitcoin network global difficulty set for all blocks Difficulty changes every 2016 blocks. Page 20

21 Types of Crypto Mining Solo Mining mining on your own! Mining pool Page 21

22 Reward systems for pool mining Proportional - Based on actual proceeds pool earns and % share of hashrate in the pool Pay-per-Share (PPS) - Instant and guaranteed payout for each share. Miners are paid out from the pool s balance Page 22

23 Audit and Accounting Implications Accounting treatment for Digital Assets Accounting treatment for Mining Revenue Audit risks related to Digital Assets Audit risk related to Mining Revenue Page 23

24 IDG Jan 10, 2018 Meeting Is Cryptocurrency an Asset? The Conceptual Framework under IFRS: Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity Criteria Past event Control How met? Entity essentially buys, transacts with, or mines a cryptocurrency (i.e., once the cryptocurrency is bought, traded, awarded or mined Entity is able to control it, as it can decide when to sell it or use it as a medium of exchange Future economic benefits Ultimately, a sale or exchange of cryptocurrency for some other goods or services will result in benefits Page 24

25 IDG Jan 10, 2018 Meeting Classification of Cryptocurrency Asset Type Factors supporting the classification Factors not supporting the classification Cash Cash equivalent Cryptocurrency represents a common medium of exchange and is widely accepted as a means of payment across the globe (similar to cash). Cryptocurrency is in the nature of a short-term, highly liquid investment that is readily convertible to known amounts of cash. It is not issued or backed by any government or state. In recent history it has been extremely volatile, hence there is a significant risk of changes in value. Page 25

26 IDG Jan 10, 2018 Meeting Classification of Cryptocurrency Asset Type Factors supporting the classification Factors not supporting the classification Financial asset Cryptocurrency represents a right to receive cash or another financial asset, or to exchange financial assets with another entity under conditions that are potentially favourable. It does not give the holder a contractual right to receive cash or another financial asset. There is no corresponding financial liability in the books of the party that would honour the value of the cryptocurrency. Page 26

27 Type IDG Jan 10, 2018 Meeting Classification of Cryptocurrency Asset Factors supporting the classification Factors not supporting the classification Intangible asset Inventory Investment Property Cryptocurrency can be sold, exchanged or transferred individually; it is not cash, but a non-monetary asset, with no physical form. Cryptocurrency is viewed similar to a commodity held for trading purposes in the ordinary course of business. Investors hold cryptocurrency for capital appreciation or as medium for exchange or both It is not specifically identifiable (as defined) because it does not arise from any contractual or legal rights. It does not have any physical form. Further it may not be held for sale in the ordinary course of business. IAS 40 is limited to real properties i.e. land and building Page 27

28 IDG Jan 10, 2018 Meeting Measurement of Cryptocurrency Asset Fair value through Profit or Loss (FVTPL) Pro is may reflect current value Pro is would reflect volatility Con is the recordkeeping and the volatility Lower of cost or net realizable value Pro is would be simpler Con is would not reflect appreciation Cost? NEVER! Page 28

29 CPA Canada Position Intangible Asset* CPA Canada concluded Not inventory (unless broker-dealer) Not financial assets Not cash and cash equivalent Not investment property It appears many cryptocurrencies are likely to meet the definition of intangible assets and are therefore within the scope of IAS 38 Revaluation model Increase in fair value in OCI Decreases in P/L No recycling. Meaning net increase in OCI, net decrease in P/L Does this make sense? Page 29

30 MNP Position Digital Asset, FVTPL None of the current standards provide most relevant information to FS users Not inventory (unless broker-dealer) Not intangible assets Not financial assets Not cash and cash equivalent Not investment property MNP s current position is that primarily, there is recognition of an asset measured at FVTPL. Sufficient disclosures should be made including significant assumptions in determining fair value, source of prices etc. Page 30

31 Measurement of Digital Asset Normally a cryptocurrency price can be observed directly from active markets (Crypto Exchanges) Sources of Fair value: CoinmarketCap - website that essentially reports market capitalization of various cryptocurrencies, and use weighed average price of all major exchanges by trading volume Crypto Exchanges Bitfinex, Binance, Coinbase (GDAX), Huobi, OKEx Page 31

32 Disclosure of Digital Asset Type and quantity of cryptocurrency is held Historical cost Fair value (IFRS 13 disclosures) Valuation methodology and technique (IFRS 13 disclosures) Purpose for holding Risk factors Page 32

33 IDG June 21, 2018 Meeting Crypto Mining Revenue Two types of mining income Transaction fee (relatively immaterial) Transaction fees are paid by party initiating the transaction to miners for their efforts in validating the transaction Block reward (more material) The reward paid to winners who first solved the has functions to generate a block Solo mining miners running full nodes and try solving the function individually Pooled mining pooled computing powers of many miners for higher probability of solving the block Page 33

34 IDG June 21, 2018 Meeting Transaction Fee as Revenue Most group members agree the transaction fees can be can be recognized as revenue according IFRS 15. Although there is no explicit contract between the miner and party initiating the transactions because of the nature of blockchain network, there is a common understanding that the miner solving the algorithm and creating new block is entitled to a transaction fee. And amount of electricity and computer hardware required support it is a business operation other than a casual investment. Page 34

35 IDG June 21, 2018 Meeting Block Rewards Solo Mining as Revenue For Common understanding block reward is paid to miner who create the next block Against There is no direct relationship between customer and miner. As a result there are no enforceable rights and obligation that may be enforced against any individual identifiable party Page 35

36 IDG June 21, 2018 Meeting Block Rewards Pool Mining as Revenue For Miners in pool agree the terms and conditions with pool operators and pay administration fees to the pool operator Against Pooling arrangement may essentially be a form of joint arrangement among the participants. It is difficult to conclude that there is a contract to provide series to pool. Page 36

37 MNP Position Revenue Crypto mining is the ordinary business activity of the entity Consideration received meets the definition of revenue While no explicit contractual relationship between the parties, the substance of the arrangement in such the rights and obligations of each party in the blockchain protocol is implied by the customary business practices and processes prevalent in the industry The nature of blockchain protocol is not possible to determine in advance the consideration that will be received, a reliable estimate of outcome of such activity cannot be made in advance of actual receipt due to uncertainties Page 37

38 Example FS Balance Sheet Page 38

39 Example FS Income Statement Page 39

40 Example Disclosure Significant Judgement and Estimate Page 40

41 Example Disclosure Significant Accounting Policy Page 41

42 Example Disclosure Digital Asset Note Page 42

43 Audit Considerations CPAB Page 43

44 Audit Considerations CPA Canada Page 44

45 MNP Audit Approach - Existence Obtain a list of crypto wallets (including both hot and cold) Validate balance on block explorers (use more than one to corroborate) Page 45

46 MNP Audit Approach Compared to price used by the Company to value the digital assets against independent source Assignment agreement proving the Company owns the wallets Test the ownership of private keys Observe login Observe cryptocurrency transfer Management representation of all crypto wallets Page 46

47 Crypto mining machines Bitcoin mining difficulty Generations of bitcoin mining equipment - Mid 2015 Bitmain Antminer S TH/s - Mid 2017 Bitmain Antminer S TH/s - Early 2018 Bitmain Antminer S9i 14.5 TH/s - Nov 2018 Bitmain Antminer S15 28 TH/s 2 to 3 years useful life Page 47

48 Price of Crypto mining machines Jun 2017: Bitmain Antminer S9 - $1,500 Jan 2018: Bitmain Antminer S9 - $3,500, to be shipped in 6 weeks And today? Page 48

49 Today Bitmain S9 Page 49

50 Impairment testing Cash inflow Using PPS formula based on the total hashrate provided by the machines Cash outflow Electricity bill Rent Labour Maintenance of machines Page 50

51 Estimating future cash inflow Miner's hashrate * Block rewards * 86,400 (Seconds per day) BTC earning per day = BTC difficulty * 2^ 32 Use current (Y/E) price of BTC Use current (Y/E) mining difficulty Perform and disclose the sensitivity information Bitcoin price +/- $1,000 Bitcoin mining difficulty +/- 100% Page 51

52 Key assumptions Expected halfing in May 2020 Useful life for mining machines: 2 to 3 yrs Bitcoin mining difficulty changes approximately every two weeks Bitcoin trades 7 days a week not 5 business days for bitcoin price volatility calculation Page 52

53 Resources Securities Regulation CSA Staff Notice , Cryptocurrency Offerings SEC Investor Bulletin: Initial Coin Offerings MNP White Paper - Cryptocurrency Accounting Implications Page 53

54 Resources CPA Canada Blockchain Technology and Its Potential Impact on the Audit and Assurance Profession Technological Disruption of Capital Markets and Reporting? - An Introduction to Blockchain Navigating the Brave New World of Cryptocurrency and ICOs An Introduction to Accounting for Cryptocurrencies IFRS Discussion Group Report - Cryptocurrencies Page 54

55 CSE Blockchain Platform Page 55

56 Page 56

57 CSE Blockchain Platform Richard Carleton

58 TODAY S DISCUSSION Why Blockchain in the Exchange World: Benefits for issuers Opportunities for public investors Investment dealer perspective The CSE s approach

59 What s in it for the issuers? Securities tokenization will reduce cost of capital and revolutionize shareholder relations and communications: Visibility of beneficial shareholders (communications, peer analysis and proxy voting costs reduced) Tax on entitlements sharply reduced: private equity deals become doable in the public markets Disintermediation of some service providers (?)

60 Public Investors Outside of the cannabis sector what s compelling about Canadian equities? Blockchain will enable companies to launch new and innovative investment products on Canadian exchanges: Streaming royalties for the mining and O&G sector IP portfolio securitization: mortgages and real estate, patents, trademarks and copyright (music, movies, images)

61 Dealer Opportunities 21 st century back office processes would be recognizable to 19 th century denizens of the counting houses : T+2 instead of T+5 Capital posted against open positions Short sale transactions: no visibility for companies Mistakes are expensive and time consuming to correct

62 THE CSE s Approach Provide a safe, regulated place for innovators and entrepreneurs to use the power of the blockchain to reduce capital costs for issuers: Provide an Ethereum-based private blockchain powered network to support a new clearing and settlement facility Use the existing exchange license to list tokenized securities of Canadian reporting issuers

63 The CSE s Approach Place the blockchain behind the securities industry firewall : same network as trading Hashing turned to zero for performance reasons Dealers and intermediaries issued digital wallets to receive and provide information from the blockchain Tokens will be held in deep cold storage forever, digital representations of tokens and cash update the chain

Timing and Next Steps CSE is in late stages of internal QA with the application Dealers (et al) will be issued digital wallets; system will be available for full life

64 Timing and Next Steps CSE is in late stages of internal QA with the application Dealers (et al) will be issued digital wallets; system will be available for full life cycle testing very shortly Integration with existing cash and customer account reporting will be the principal challenge 6 to 9 month approval process from the regulators

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66 Thank You

Accounting for crypto assets mining and validation issues

Accounting Tax Global IFRS Viewpoint Accounting for crypto assets mining and validation issues What s the issue? Currently, IFRS does not provide specific guidance on accounting for crypto assets. This