Views on improving the integrity of global capital markets
29 October 2018

Bitcoin: The End of Trust in Accounting and Finance

Transactions are the foundation of accounting and finance, trust is the foundation of transactions, and currency is the foundation of both accounting and finance and transactions. In its simplest form, a transaction is a “trust” agreement between a buyer and a seller. The seller promises to provide goods and/or services to the buyer, and in return, the buyer promises to pay the seller a specific amount of currency. Transactions not only require that the buyer and seller trust each other, they also require that the currency exchanged functions as a 1) store of value, 2) medium of exchange, and 3) unit of account. The buyer and seller must also trust 1) their government not to debase the currency and 2) their financial institutions to hold their money and to transfer it electronically once the transaction is completed.

Bitcoin and the Elimination of Trust

Bitcoin is a currency that obviates the need for trust in accounting and finance and in transactions.

  • Because bitcoin transactions take place on a “peer-to-peer” basis, there is no need for financial institutions or to have trust in them.
  • Because a maximum of 21 million bitcoin can be produced, there is no longer a need to have trust in the government.
  • Because bitcoin is based on blockchain technology that verifies the transfer of funds, there is no need to have trust in the counterparty to the transaction. Smart contracts use computer programs to execute transactions once specific conditions are fulfilled. As a result, transactions are conducted on a guaranteed basis because collateral is posted instead of withheld.

Does bitcoin’s elimination of the need for trust in accounting and finance and in transactions make it ethical or unethical? The simple answer is that bitcoin is neither. The use of bitcoin is ethically neutral. The purposes for which bitcoin is used, however, can be ethical or unethical. Bitcoin’s quasi-anonymous nature (bitcoin is associated with an IP address, not a name) makes it easier for those who are so inclined to use it to pursue illegal activities and circumvent government rules and regulations. On the other hand, bitcoin can facilitate and reduce or eliminate the cost of transferring money to family and friends who live in far-flung places.

The Investment Perspective on Bitcoin

From an investment perspective, the current furor over bitcoin is reminiscent of the Dutch tulip mania. During the early 17th century in the Netherlands, speculation in and trading of tulip bulbs drove prices to ridiculous heights, creating a bubble that eventually burst. In its wake, many people went bankrupt or were financially ruined. Since 1 October 2017, bitcoin’s value has risen from USD4,391 to a high of USD19,378 on 17 December 2017. As of this writing, bitcoin’s value is USD6,605.

Given bitcoin’s price volatility, it is difficult to view it as a store of value or a medium of exchange. Nor is it possible to determine the fair market or intrinsic value of bitcoin or to estimate an objective price. Traditional valuation methodologies or models to value bitcoin are useless because they incorporate expected cash flows and the time value of money, but bitcoin has no current or future expected cash flows. Because bitcoin cannot be valued objectively, calling bitcoin an “investment” or encouraging unsophisticated investors to purchase it is unethical. Those who purchase it are doing so purely for speculative purposes, which is similar to gambling in that the odds and profits are in favor of the firm selling it or a product based on it.

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Photo Credit: ©Getty Images Mark Garlick/Science Photo Library

About the Author(s)
Michael McMillan, CFA

Michael McMillan, CFA, is director of Ethics Education at CFA Institute, where he was responsible for creating, sourcing, and developing educational content for CFA Institute members and investment professionals in the area of ethics and professional standards. Previously, he was a professor of accounting and finance at Johns Hopkins University’s Carey School of Business and George Washington University’s School of Business. Prior to his career in academia, McMillan was a securities analyst and portfolio manager at Bailard, Biehl, and Kaiser and at Merus Capital Management. He is a certified public accountant (CPA) and a chartered investment counselor (CIC). McMillan holds a BA from the University of Pennsylvania, an MBA from Stanford University, and a PhD in accounting and finance from George Washington University. Topical Expertise: Financial Statement Analysis · Standards, Ethics, and Regulations (SER)

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