Ownership of mining rewards – by Dr. Andrei Belonogov

One crucial moment in the understanding of blockchain accounting is the understanding that public blockchains have an enforcement mechanism enabled by its protocol. The protocol ensures the execution of blockchain algorithms internally. Although it lacks legal status, the protocol ensures adherence to the network’s rules with a level of certainty unattainable by the enforcement mechanisms of any single legal jurisdiction.

An essential part of any protocol is its consensus mechanism. I’ve always seen consensus mechanisms as falling under the category of ‘customary business practices’. These practices, followed in practice by blockchain participants, create reasonable expectations regarding their entitlements and obligations. These practices also create rights that can be enforced by the blockchain protocol. Example:

If network participants send digital assets to the wrong account (by mistake), they effectively lose the assets. No recovery mechanism can enforce the return of assets to their legal owners. The account receiving the digital assets may not have existed before the transfer, and it may remain ownerless until someone eventually generates a private key matching this public account address. There is even a saying “Not your keys, not your crypto”.

Understanding the protocol as an enforcement mechanism leads us to a deeper understanding of blockchain accounting and auditing.

Let’s now turn to the practical accounting implications of the protocol being an enforcement mechanism. In this context, I wish to counter the position stated by CPA Canada in their publication “Crypto-asset mining: auditor considerations” There are two ways to operate a proof-of-work mining business:

1. The entity operates as an independent miner

The rewards distributed to the entity from the coin base are the rewards that the entity is eligible for the mining services performed. It is an irreversible allocation enforced by the blockchain protocol. There is no central organization with authority over all parties involved in the process. It is often not even possible to learn which jurisdiction another party belongs to. So the protocol is the only mechanism of enforcement that each party is required to follow. Hence, the raw blockchain data that contains a record of the transaction by itself proves that rewards were earned by the entity.

2. The entity operates as part of a mining pool

This scenario is different. Legal rights and obligations of the entity now arise from the existing arrangement with the mining pool, which is typically a legal entity formed under the law of a known jurisdiction. To prove the ownership of rewards, one would need to evaluate the rewards earned and recorded on books in the context of reports received from the pool operator, terms and provisions of the mining pool agreement, and consider other circumstances based on specific fact patterns.

Further, the fact that digital assets were received by the entity is only relevant to accounting for mining rewards if there is a certainty that proceeds were received from the mining pool operator’s address. Otherwise, the entity’s accountants may erroneously record receipts of digital asset borrowings as revenue and we would not be able to identify this based on the results of our procedures.

Additionally, I would like to comment on the analytical procedures outlined in the CPA Canada guide, as they relate to audit evidence concerning mining rewards recorded as revenue. I believe that in practice, it cannot provide any more meaningful or robust evidence than tracing rewards to the blockchain raw data. This is because the data source for hash rates of mining pools is not reliable.

Because the blockchain protocol acts as an enforcement mechanism, (and sometimes, as the only enforcement mechanism) in certain scenarios, the blockchain transactional data (together with the memorandum that carefully evaluates relevant facts and circumstances) may constitute sufficient audit evidence of the ownership of mining rewards. It is worth stating that, sometimes, all that auditors need to do to comply with the standards, is just to document the rationale behind the procedures they performed.