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A Digital Currency (also referred to as a “cryptoasset” or “cryptocurrency”) is ultimately defined by reference to the rules of the system in which it exists.
There are a number of Digital Currencies in existence in the world today. The core principle behind the concept of a “cryptocurrency” is the use of cryptology, being the sophisticated mathematical algorithms and the secret keys used to encrypt and decrypt data. Typically, cryptography is used to provide secrecy and integrity to our data and both authentication and anonymity to everyday uses such as our communications, internet browsing and digital commerce.
Digital Currencies take these traditional concepts of cryptology and combine them with a public ledger technology known as the ‘blockchain’ on which all digital currency transactions are recorded. This public ledger provides a transparent record of transactions which have occurred.
To achieve security and ensure that only the owner of the Digital Currency both owns and has title to the Digital Currency in their possession, transactions involve a ‘Private Key’ and a ‘Public Key’. The owner of a Digital Currency should keep the ‘Private Key’ confidential, whereas the ‘Public Key’ is published on the blockchain. In this sense, there are always two components to a transaction, representing a pair of data parameters, one public parameter (in that it is disclosed to all participants in the system or to the world at large) and one private parameter.
The private parameter (“the Private Key”) permits transfers or other dealings in the Digital Currency to be cryptographically authenticated by digital signature. Knowledge of the Private Key confers practical control over the asset; it should therefore be kept secret by the holder. More complex Digital Currencies may operate with multiple Private Keys (multisig), with control of the asset shared or divided between the holders.
When the owner of a Digital Currency decides to transfer their Digital Currency, they sign or authenticate using the Private Key to validate the transaction. This is similar to using a “pin” on an ATM card, which only the owner should know. Once this “pin” is entered, the details of the transfer are “published” to the blockchain, where the public parameter contains or references encoded information about the asset, such as its ownership, value and transaction history. As part of this “publishing” process the specific details are broadcast to a network of participants and once confirmed as valid, added to the relevant digital ledger. The main function of the ledger is to keep a reliable history of transactions.
A key purpose of this validation is to stop the concept of double spending.
Using a traditional banking analogy, this is similar to you having an account with $100 in it, and you trying to spend it simultaneously online and at the ATM. In that situation your bank would only allow one transaction. With cryptocurrency this safety check is conducted via the public ledger.
The ledger may be distributed and decentralised, that is, shared over the network with no one person having a responsibility for maintaining it, or any right to do so. A common type of distributed ledger uses a Blockchain, which comprises blocks of transactions linked together sequentially, but other models are also in use.
Although not all systems possess all of them, the main characteristic features of Digital Currencies are as follows:
- cryptographic authentication;
- use of a distributed transaction ledger;
Blockchain typically stores three distinct pieces of information:
- Information about the transaction
- Details such as the date, time and amount
- Who participated in the transaction
- Who has sent and received in the transaction
- Distinguishing information
- A cryptology-based key, referred in the industry as a “hash” which acts as a ‘fingerprint’ to each transaction.
A cryptology-based key, referred in the industry as a “hash” which acts as a ‘fingerprint’ to each transaction.
Some Digital Currencies are intended to represent or are linked to conventional assets external to the system, for example money or debt obligations, tangible goods or land, a share or unit in a company or fund, or a contractual right of some kind; those assets are sometimes referred to as “tethered, exogenous” or “off-chain”. Such an external asset is certainly property but what, if any, rights in it conferred on the holder of the corresponding Digital Currency will depend on the contractual structure or legal rules of the Blockchain system. We consider that Digital Currency itself (the native or on-chain asset) is property, as distinct from any other asset it might represent.
Bitcoin is a type of Digital Currency; however, it is not a currency in the traditional sense, but it is a digital means of payment. It is decentralised without a central bank or single administrator. The digital payments can be sent from user to user on the peer-to-peer Bitcoin Network without the need for intermediaries.
For a more detailed description of Bitcoin visit “What is Bitcoin” page on our page.
Bitcoin Mining is the process by which Digital Currencies such as Bitcoin and Altcoins are minted and released for circulation onto the Blockchain.
To create new blocks on the Blockchain (through Digital Mining), specialised computers (known as miners or ASICs) must both verify the previous transactions and solve a complex computational math problem known as a “Hash”. The cryptographic work that a Miner performs to solve the math problem or “equation” (as it is sometimes referred to) is known as their “proof of work” (POW). The POW requires a Miner to come up with a 64-digit hexadecimal number called a “Hash”, that is equal to or less than their target Hash.
Miners continue to rapidly solve Hashes until they arrive at a solution. Given this process, Digital Mining becomes a process of increasing Hashing Power and statistical probability.
A reference to a Miner is a reference to an application-specific integrated circuit (ASIC) computer.
Where a Miner solves a Hash, a Block is incorporated onto the Blockchain and the Miner receives a Block Reward in the form of a Digital Currency, usually Bitcoin (or fraction of a Digital Currency).
A cryptocurrency wallet is a software program that stores private and public keys and interacts with various blockchain to enable users to send and receive Digital Currency and monitor their balance.
If you want to use Bitcoin or any other cryptocurrency, you will need to have a cryptocurrency wallet.
The trustee of the Wholesale Fund has an account with one or more Digital Exchanges, the main one being Independent Reserve. The account enables the trustee to buy, own and trade in Digital Currencies (including Bitcoin).
The Bitcoin is valued using the Bitcoin Access AUD Reference Rate which is a benchmark of Australian Digital Exchanges combined with global Digital Exchanges in Australian Dollars (AUD),to create a weighted average (on trade volume) Bitcoin price.
Digital Currency risks – Digital Currencies can be extremely risky and are usually highly speculative. Anyone who acquires Digital Currencies directly or indirectly (for example by acquiring Units in the Fund), should be aware that there is a high risk that their investment could be lost. There is the possibility that sometime in the future Bitcoin may have no value. This risk may render it unsuitable for most investors. Risks associated with investing in a fund exposed to Digital Currencies include:
- Extreme volatility and bubble risk – Most Digital Currencies are subject to extreme price volatility and have shown clear signs of a pricing bubble (being a significant, sustainable rise above the reasonable value of Bitcoin). If you invest in Bitcoins or an investment product exposed to Bitcoin, such as the Fund, you should be aware that you could lose a large amount, or even all, of the money invested. If the price of Bitcoin depreciates significantly, this will have a direct adverse impact on the return to Unitholders.
- Absence of protection – Despite anti-money laundering requirements being introduced globally, Digital Currencies remain relatively unregulated under laws globally. Similarly, exchanges where Digital Currencies are traded and digital wallets used to hold, store and transfer Digital Currencies are largely unregulated under law too. This means that if you buy or hold Digital Currencies, you will not benefit from the guarantees and safeguards associated with regulated financial services. >Lack of exit options – There is a risk of not being able to trade Digital Currencies or to exchange them for traditional currencies, such as the US dollar, for a long period of time. You may suffer losses in the process. >Lack of price transparency – The price formation of Digital Currencies is often not transparent. There is a high risk that you will not receive a fair and accurate price when buying or selling products that invest in Digital Currencies.
- Operational problems – Some Digital Exchanges have experienced severe operational problems, such as trading disruptions. Consumers have suffered losses during these disruptions as it restricted their ability to buy and sell Digital Currencies. It is possible that a Digital Exchange may become insolvent or it is possible that other clients of a Digital Exchange may cause a default which reduces the financial resources or capacity for the Digital Exchange to perform its obligations owed to the trustee in relation to (among other things) exchanging its Digital Currencies for Fiat Currencies.
- Misleading information – Information available to consumers wishing to buy Digital Currencies is limited and most may be misleading as it tends to be incomplete, difficult to understand and fails to properly disclose the risks of Digital Currencies.
- Unsuitability of Digital Currencies for most purposes, including investment or retirement planning – The high volatility of Digital Currencies, the uncertainty about their future and the unreliability of Digital Exchange platforms and wallet providers make Digital Currencies unsuitable for most consumers, including those with a short-term investment horizon but especially those pursuing long-term goals such as saving for retirement.
- Key risk – The Private Key required to access a Digital Currency may be lost, destroyed or stolen resulting in Cosmos Asset Management being unable to liquidate the Digital Currencies, which would adversely affect your investment in the Fund. The Private Key(s) of the majority of the Wholesale Fund’s Bitcoin investments will be held in Cold Storage. “Cold Storage” means that the Private Keys are held in an offline digital hardware storage device that is stored in physical vaults in geographically diverse locations, and where each vault is secured by multiple levels of physical and biometric security. While these arrangements are intended to minimise the risk of the Private Keys being lost, destroyed or stolen, there is no guarantee that these events will not occur.
- Uncertainty about future use of Digital Currencies – Digital Currencies are a relatively new concept and asset class, so there is still some degree of uncertainty and pessimism about their use and so whether their popularity will gain further traction is difficult to predict. If the popularity and use of Digital Currencies diminish and leads to their value decreasing, the Fund’s existing and potential further interest in Digital Currencies would be detrimentally affected.
- Regulatory risks – Currently in Australia, Bitcoin in and of itself is not a financial product nor is Digital Currency regarded as money or currency for the purpose of the Corporations Act. The effect of any future regulatory change on Digital Currency or an entity dealing in or holding Digital Currency is impossible to predict, but such change could be substantial and adverse to the returns sought by the Fund. While Bitcoin is presently legal in Australia, it may be illegal now, or in the future, to acquire, own, hold, sell or use Bitcoins in one or more countries. Regulatory changes or interpretations could cause the Fund, the trustee and Cosmos Asset Management to register and comply with new regulations, resulting in potentially extraordinary, recurring or non-recurring expenses to those holding Digital Currencies.
We have a partnership with Independent Reserve to provide execution, security, Cold Storage and Hot Storage of the majority of Bitcoin assets held by the Wholesale Fund.
We have established relationships with a number of other Digital Exchanges which we are able to use from time to time. However we need to verify and validate the security procedures, insurance and processes before we use an alternate Digital Exchange.
There are a few ways to meet the criteria of a wholesale investor as defined by the corporations act 2001.
Generally, to qualify as a wholesale Investor you must meet one of the following criteria:
- invests $500,000 or more in the Wholesale Fund;
- provides a certificate from a qualified accountant (substantially in the form attached to the application form that accompanies the information memorandum) that states the Applicant has net assets of at least $2.5 million or has a gross income for each of the last two financial years of at least $250,000; or
- is a professional investor (including the holder of an Australian financial services licence, a person who controls more than $10 million, or a person that is a listed entity or a related body corporate of a listed entity).