A Risk Expert’s Opinion on ‘Auditors of Crypto Assets struggle to satisfy PCAOB’
As auditability and compliance becomes an increasingly important factor for the Digital Asset Industry, auditors, digital asset firms, and investors find it difficult to demonstrate the ownership of digital/crypto assets as required by regulators and auditing standards. These audit requirements require digital asset businesses to ensure and demonstrate safety and soundness of their business model and customer and consumer asset related operations. The recent article “Auditors of Crypto Assets Struggle to Satisfy PCAOB” (CFO magazine August 2023) outlines these concerns from an auditor’s point of view. The article also provides insight for digital asset businesses as to the risks that require attention to ensure safety and soundness over assets under their control and custody. A key point made in the article is that digital asset businesses must establish appropriate governance and controls to ensure compliance and proof of asset ownership and auditability across the full value chain. This is especially critical, given the nature of crypto-assets and the anonymity provided by the digital asset alpha-numeric keys. Compared to traditional financial products asset ownership is obfuscated by these digital keys. If appropriate controls are lacking digital asset business and their customers face increased risk of fraud, theft, and non-compliance in relation to asset ownership, increasing the reputational risk across the industry. Below are some of the factors impacting the level of risk for firms and investors:
Depending on the custody model, key type and crypto-wallet (see image above) applied combined with a firm’s terms and condition co-mingling of a firm and customer funds is possible thus creating audit and asset ownership questions adding to the reputational and legal risk for digital asset businesses. This risk has been highlighted in recent bankruptcy litigationCelsius Network LLC, where asset ownership transferred to the bankruptcy estate given the terms of use of the earn accounts customers assets were held in:
- BlockFi - where asset ownership stayed with the customer given the terms and conditions of the non-interest-bearing wallets assets were held in
- FTX - probably the best-known case, where the ownership decision of $7.3 billion in assets is still outstanding
In addition the Crypto-Industry has an integrated value chain from mining to trading and custody to payment processing thereby creating counter-party risk across the industry. This counter-party risk is a critical element requiring proportional governance and controls given the speed of evolution of the crypto-industry. Given the speed of evolution and large turnover in the industry, as highlighted by the roughly one dozen bankruptcies documented in the “Crypto-related bankruptcy timeline” by PerkinsCoie in 2022/23, managing counter-party risk is critical to the safety and soundness of any digital asset business.
Digital Asset Businesses can protect themselves from the reputational, legal, and counter-party risks by implementing proportional and scalable Risk Governance and Controls to ensure assets are managed and accounted for, thereby providing safety and soundness for their customers and investors.
It’s Time to Evolve
At Clarendon Partners our Risk Practice provides growing Crypto, FinTech and Financial Services clients with deep expertise in Governance, Risk, and Compliance to help them grow their business and implement proportional Risk Management Frameworks by providing fractional Risk leaders, outsourced Risk services, or project based solutions. Our Risk experts are here to help you evolve!
Contact us at digital@clarendonptrs.com to discuss how we can help.