The term cryptocurrency might sound futuristic, but it is quickly emerging in the present as an opportunity for many in the public and investing community. It’s vital that CPAs and financial planners know what they are, why they are attractive to clients, and what the risks are. To go into detail on cryptocurrencies, we talked to Matthew May, COO and founder of full-service financial firm Acuity.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
It may sound futuristic, but cryptocurrencies are quickly becoming an option for many among the public and investing community in the present day. CPAs and financial planners need to know what they are, why they're attractive to clients, and what the risks are. To go in depth on cryptocurrencies, today we are with Matthew May, COO and founder of full service financial firm Acuity.
Now for the uninitiated here, can you tell us a bit about cryptocurrency? Maybe the origins and how it works?
[May] There's lots of secrecy and confusion really about how it got started. But there's either a person or a group of persons that call themselves Satoshi that did a white paper about blockchain and introduced bitcoin to the world. That's kind of where we started with cryptocurrencies and then somebody started mining, as they outlined in their white paper, and we have this first currency that's out there that's not really sponsored by a government.
What would you say is the current popularity level of cryptocurrency with the public and the investing community right now? Is awareness and use of it rising quickly?
[May] Well, if you had asked me a year ago at this time, I would have a very different answer. A year ago at this time, the cryptocurrency markets were going through the roof. And you were having increasing awareness every month, month over month, and you are seeing volumes increase. Over the last year, we've seen a steady decrease in the values of cryptocurrency. The FOMO or the fear of missing out, now with people has gone down.
But your question, I think, right now there's a steady skeptical optimism maybe around cryptocurrency in the public. I'm not sure whether we can call it an investment yet.
Before we get into some of the risks of cryptocurrency, I want to be fair and talk about some of the positives. What are those perceived to be thus far in the existence of cryptocurrencies?
[May] I think a lot of the philosophical positives about cryptocurrency really center around this notion of some of the governments, and how they manipulated their nation's state like actual fiat currencies, so their currencies in those nations.
So especially for a currency like Bitcoin, there's a certain group of people that think it's very positive to see a decentralized, so no single control point for a currency out there. And also a big supply, a supply that could be tinkered with. You see the U.S. can add dollars at any time. China can manipulate their currency, and has for decades. So, I think that's the biggest positive people point to.
What are the challenges in terms of liquidity?
[May] Well, there's three buckets of liquidity challenges in cryptocurrency. There's cryptocurrencies that, can you can actually get cash? They pose one type of risk because we said there's about 2,000 cryptocurrencies. Five or six fit in this category of you can get it to some kind of cash, some U.S. dollars, some other foreign currency. And there's the second set, kind of maybe 200, 250 currencies that you can exchange into one of those currencies relatively easily. In cryptocurrency exchanges, there's 1,000s of those out there. You can get 200, 250 or so of these cryptocurrencies to a currency that you can get to dollars. And then there's like 1,700 or so that are kind of out there in the ether, that are really illiquid. So really understanding which of those buckets the cryptocurrency you are talking about comes from is really helpful for people that are novices in the space.
That's interesting. So you think you hear the word cryptocurrency as a novice, you think of one specific thing. But you said there's over 2,000 different versions of it?
[May] There's over 2,000 different varieties. And they all have different purposes. They're not all trying to be the same thing. It's just really interesting. So you really have to dig in. Most of the popular ones definitely are heading to ... like Bitcoin is the most popular one. We're seeing people think of it in the markets as kind of an alternative to gold, or an alternative to a stored value. But then you see other currencies that are more along the line of Bitcoin Cash and we saw that slip. They're trying to really just displace for people that need maybe an alternative currency in their country or alternative currency for international transactions, things like that.
How about counterparty risk? What are the issues in the area?
[May] Well, this is the big one, right? When people worry about fraud or talk about losing cryptocurrency, almost all of the registered cases of losses happen at the exchanges. So these exchanges where you are able to convert cryptocurrency to fiat governmental currency, or cash, those places have been the point of attack or fraud that have really given cryptocurrencies a bad name. Very little fraud or challenges have happened on the blockchain, this computer code where it’s very difficult to change the way the algorithms have worked in most of the solidly built currencies. So the counterparty risk is one people almost gloss over because they're starting to think of these places like they're banks. Banks, we take for granted in the United States, they're FTIC insured, right?
So you have people making the mistake of keeping money or cryptocurrency in these exchanges, and then if something happens to them, if you think about that snow day, like the same thing happens to the banks that were a little sketchy. So you really need to think about those exchanges in terms of counterparty risk, and really be cautious of it. We encourage our clients to only use those exchanges to exchange, like you send the cryptocurrency there, you exchange it for whatever you want and you get it out. There's several devices that we use for the storage ops, kind of offline, that really help decrease that risk.
Are there risks in terms of the volatility of cryptocurrency at this point? And how can that fluctuation affect business or personal financing?
[May] The volatility is the one that seems to get all the headlines. I think everybody understands ... I was just looking at a seven-day period this month at the first, I think it was the first, week of December, and Bitcoin was the most heavily transacted cryptocurrency, fluctuated 15% up and down in a seven-day period. And when you are talking about 15% swings in a seven-day period, you're talking about all kinds of problems and issues with stability, if you're trying to hold that currency or use it on a day-to-day basis. But I think that people need to remember, while that's a risk, that's potentially or hopefully for those that are kind of long cryptocurrency, that's a short-term risk because once people start using these cryptocurrencies for their intended use, more than you see people speculating, you should see some stability there.
Most of the economists who I have talked to, ones that ... I've been looking to plug into some folks that help advise for the Fed and they're looking at this space as well saying, "Okay, as soon as these companies and these cryptocurrencies get some volume for the purposes for which they were intended, then you'll see the speculators be less of a proportion of the volume that's getting transacted." And speculators are driving most of the volatility right now, so the companies you'll remember that are backing some of these cryptocurrencies and there is concern there, first you know most of them are in their first one to four years existence and their projects for cryptocurrency haven't really taken off yet. And we'll see some of them start taking off here in the next two to three years. And then we'll start seeing some of that shift, but it's going to be slow.
Now speaking of volatility, instability, I had seen a great piece that you did on this topic in the preparation I was doing for the discussion, and transaction fees are sort of seen to be an issue, with some seen to be as high as $30 per transaction and some being as low as a penny. That's a pretty decent spread. How can a transaction fee be that high and that low, and why is there such a vast fluctuation in the fee pricing?
[May] Remember these are decentralized networks, that are on most of these cryptocurrencies ... a couple of them like Ripple are centralized which are seen as penny transaction fees. But on the decentralized networks, we'll talk about those first, with Bitcoin being the most popular decentralized network. You have people out there that are running computer systems and paying for power, and there's been lots of press about the cost. And they're only going to do that to the point where the transaction fees you pay on the network that they get paid, that has to be more than their power bills and their costs of running the mining equipment. So part of it has to do with supply and demand of the underlying network and support and the infrastructure.
One thing that's really important to understand is, for some of the networks, they really don't have any incentive or they really don't care to tie transaction fees down. Like on the Bitcoin network, I think that they're philosophically trying to be more like gold, so you don't really transact gold like everyday. You're not trying to pay for things with gold.
But when you saw Bitcoin and Bitcoin Cash split, you saw the philosophical kind of group that wanted low transaction fees. Big changes to the code and the algorithm behind the scenes in Bitcoin Cash to have these lower transaction fees for people that wanted to use it for payment replacement. There's some great problems here. Some of my clients that are using cryptocurrency for micro payments, they're making hundreds of thousands of payments. So if you're talking about any kind of fluctuation in these transactions fees, and we’re seeing crazy reasons for that in the market, clients saw transaction fees spike in January or February of this year when CryptoKitties came out. Because CryptoKitties is on the Ethereum chain and their token is on the Ethereum chain, and everybody needed Ethereum to transact on that chain. So when people are going crazy about trading CryptoKitties, doing collections, the other tokens on the chain had to pay the price in that the Ethereum fees went up. So it was thousands of dollars for our client on transaction fees. So we're really starting to make sure that ... or one of the things that I've been trying to do is make sure our accountants are aware. We didn't need to really consult our clients and make sure they're making business decisions, making the business be the best micropayment platform since sliced bread, that they pick a platform for those micropayments that's focused on lowering transaction fees, places like Ripple and Bitcoin Cash, not some of the other cryptocurrencies.
What are the storage options at this point for cryptocurrency and what are the risks associated with them? How susceptible are they to cyber criminals? Is that a major concern?
[May] There's two main storage options. There's giving your cryptocurrency to a third party, like an exchange. Most of the risk I see lie there. If that happens, then you're worried about the exchange staying in business. You're worried about the management of the exchange being ethical and not stealing your cryptocurrency. You're worried about hackers going into the software because most of the exchange is software that isn't blockchain-based because they're using it to transact, and hacking in that. So that's kind of the riskiest of the storage options.
Then there's the storage option where you control what they call your private key. And if you think of your private key – basically think of it as your signature or your fingerprint – nothing can happen without your private key. There's software solutions and hardware solutions for maintaining your fingerprint on the blockchain. The hardware options are the easy ones, I feel like I'm able to use a little USB type drive. The two most popular brands out there, one's called a Trezor, and one's called a Ledger. Those are really relatively simple devices. They just plug into either your phone or your USB drive on your computer, and basically house your fingerprint for the blockchain, which basically says, you know, on this block, Matthew owns X amount of Bitcoin. So it keeps all those records. Well, the blockchain stores that. It's just the fingerprint allows you to move it wherever you want whether you want to transact something or not.
And then there's some of the software options. One popular one's called Parity, which has had some hacks, questionable things happen to it. And one's called Genesis, which has been a little bit more secure and hasn't had a major hack on the software side.
How important would you say it is right now for CPAs and personal financial planners to get up on the pros and cons of cryptocurrency? So they're not playing catch-up when it really begins to take off amongst their clientele. When should we expect this to really take off?
[May] I think right now is really important time to educate and what I try to do is educate CPAs and managers on really practical initial steps for people, really kind of almost simple rules of thumb. At least at this point, I think it’s likely that a form of cryptocurrency will be popular in the near term, and the near term is the next five years. People that question that, I say, well, okay, what if Amazon decided you can only use Amazon coins to buy stuff on Amazon? And then people are like, that's probably a game changer. What if there's three governments that decided to use cryptocurrency? What if the U.S. government came out and said, okay there's a cryptocurrency that can be exchanged for U.S. dollars 1 for 1 and you can use it?
There's a couple game changers that can happen in the next five years where that really won't be a question and everybody will be out there. But for people that are skeptical, I say, okay. one of the really interesting things that happened in blockchain, which is the technology that underlines cryptocurrency, is Wal-Mart has told their suppliers and the supply chain that they have to be on their blockchain to be part of their supply chain starting in 2019. So how far are we then from Wal-Mart saying, okay we'll have a token or cryptocurrency that's basically like a Wal-Mart coin, that maybe 10 U.S. dollars ... a lot of currency, maybe the euro. The next step for them is to say, now if you're in our supply chain once you deliver you get paid immediately in cryptocurrency or in a form of cryptocurrency that's linked to our blockchain and all those payments happen real-time and you start easing people paying on the working capital side.
There's a couple of things that can happen, that makes this something that the game changer might accelerate, I guess. But in the mean time, you’ve got to know people are asking these kind of questions all the time in our profession. Just have to ... and telling them to stay away doesn't really work for most people. That just pushes them out on their own. So preparing them for some of the risks, and talking about some of the guidelines that some of the wealth managers are saying, you know, giving them some rules of thumb. That's what I've been focused on in the early stages.