Do you have clients who have started accepting or investing in cryptocurrency? As blockchain-based technology makes waves in every sector of the business world, accounting professionals should be prepared to answer client questions, as well as be proactive with considerations for their clients, as they consider implementing it in their businesses.
In the first article of this series, we talked about future-proofing your firm by making sure that your clients are informed about the consequences, both positive and potentially negative, of holding or accepting cryptocurrency. We posed three questions to ask your clients: Which cryptocurrency are they using, how much risk can they tolerate, and how are they securing their crypto?
The final security point involved nodes, which brings up more potential learning opportunities for your clients as we take a deeper dive into the mechanics of utilizing cryptocurrency and/or the use of blockchain in general.
1. Getting smart with smart contracts
A smart contract based on blockchain technology automatically auto transfers digital currencies under the terms and conditions of a contract, and allows for full visibility among parties. The smart contract is meant to capture contractual obligations, while minimizing reliance on third parties. The cost of completing a transaction should also decrease with smart contracts because of there being less hands in the mix of a transaction. Smart contracts also should save time and money by eliminating the wait time between party actions, and allow for autonomy between the involved parties. Blockchain-based contracts can’t be altered, but they can be audited.
When discussing smart contracts with your clients, talk about their benefits as well as the limitations. While smart contracts are compelling, they do not include a dispute resolution mechanism, which means you may still need to seek the advice of an attorney and ensure everyone is properly protected under the terms of the agreement.
2. What about nodes?
A node is any electronic device that is connected to the internet with an IP address. Nodes contain and maintain a copy of a blockchain. Each cryptocurrency has its own set of nodes, which can consist of net-enabled computers, phones, or other smart devices, used to maintain records. The number of nodes in a blockchain determines how secure it is. Find out what your clients know about the nodes (how many nodes there are in the system, how mature the blockchain is, etc) associated with their network so they can assess the security and risk of the cryptocurrency they choose. For example, the less nodes that are in the system, the more risky it is for vulnerabilities.
3. Hot and cold Wallets
Determine what kind of backup procedures clients have in place to ensure their key addresses won’t get lost or stolen. The problem with how people backup their crypto key addresses is that they do not necessarily follow a best practice, nor does there exist consistent guidance to help them. Take Bitcoin for example: If you don’t have control of your private key address, or lose it, your Bitcoin does not belong to you — it belongs to the holder of the private key address. Ask your clients if they have a wallet and if they have properly backed up their keys. Every time a transaction is made, a new address will be generated by Bitcoin along with words to generate keys.
A hot wallet is storage of cryptocurrency key addresses that’s connected to the internet, while a cold wallet is offline, with the address written on paper, metal or wood. A hot wallet, or a wallet that is stored online, is susceptible to hacking, while a cold wallet is not; however, it’s possible to lose a cold wallet. It’s not uncommon for people to store their least profitable cryptocurrency in cold storage and memorize the passphrase. With warmer wallets, you might see clients using hardware that is pin protected or that uses a passphrase. Another common storage practices include using multi-signature, or multi-factor, hot wallets containing smaller amounts of addresses associated with the cryptocurrency.
If your client has a lot of Bitcoin, there are also USB devices like Ledger and Trezor that can be used as a highly secure hardware wallet. Alternatively, there is software like AirBitz, for example, that you can install on your phone. Bitcoin also recommends security measures like encryption and backups to further protect accounts.
As blockchain transforms the profession by way of improved processes, the technology also allows you to provide a higher level of value and more robust advisory services to your clients. Now, more than ever, it’s important to use your time wisely and learn common practices around cryptocurrencies, and to educate them on how to best protect their financial futures.