Cryptocurrency exchanges are implementing systems to verify certain assets and liabilities intended to reassure investors and customers following the collapse of FTX last month, but these measures provide limited insight into company finances. .
In recent months, several crypto exchanges, including Binance Holdings Ltd. and Crypto.com, have hired external auditors to provide a proof of reserves report, an increasingly popular type of attestation that can show that the company is solvent and has enough assets to cover its debts. . Most crypto exchanges are private, meaning they don’t have to file financial statements with the Securities and Exchange Commission or have them audited.
The process aims to give investors certainty that their tokens are backed by reserves and that their funds are safe, but reporting is not as comprehensive as an audited financial statement.
Binance said it on Wednesday chartered accountancy firm Mazars to verify its reserves independently. Crypto.com plans to release verified proof of the reserves in the coming weeks, a spokeswoman said. Several other exchanges have announced their own efforts to develop their proof of reserves systems in different ways, not all of which involve an external accounting firm.
These auditors do not personally sign the certificates, unlike the review of the annual financial statements of a public company. Reserve proof attestations are not public, but some companies such as Kraken share reserve data with their customers. Kraken allows clients to independently verify that their balances are backed by assets backed by the exchange. Kraken, which has completed two proofs of reserves in the past year, plans to further increase the number of assets covered in future certifications, a spokeswoman said. Binance could not be reached for comment.
Some crypto exchanges and their auditing firms have said they audit reserves based on standards set by the American Institute of Certified Public Accountants, which sets rules for auditing US private companies.
Worries over the solvency of currency platforms took center stage amid the implosion of FTX, which lent billions of dollars from its own customers to a subsidiary, Alameda Research, and blocked customers from FTX to access their money. FTX, however, had also led a complete audit of its finances over the past two years from its auditors Armanino LLP and Prager Metis CPAs LLC, an uncommon move in the industry.
“Things like, you know, proof of reserves is helpful,” FTX founder Sam Bankman-Fried said during a New York Times event earlier this week. He added that clients of crypto exchanges should “research this as rigorously as you can research regulatory reports.”
Such third-party verification represents a step towards more transparency around crypto exchanges, but there are significant shortcomings, some scholars have said. Investors are generally unaware of whether platforms have pledged client assets for loans or changed their asset or liability calculations in the meantime when reserve snapshots are provided. The exchange also determines the frequency with which these certifications are made.
“Investors might assume that this attestation is similar to a full audit when in reality it is not comprehensive and does not disclose all assets or liabilities or discuss controls,” said Deniz Appelbaum, professor accounting and finance assistant at Montclair State. University.
A Proof of Reserves report provides an overview of certain assets owned by the exchange, such as crypto holdings and fiat currency, which is government-backed currency with no fixed value, at a specific time. But, this usually does not include, for example, non-crypto assets such as shares of a stock trading platform or commercial paper. Verifications are useless unless auditors consistently provide them due to the high trading volatility of crypto stocks, Appelbaum said.
Exchanges could have hidden liabilities and have creditor claims over their digital assets, but those details won’t be clear from a proof of reserves statement, said University of Minnesota accounting professor Vivian Fang. . “Whether someone else has claims to these digital assets is uncertain,” she said.
Companies using third-party verification also do not have to provide auditors with information about assets or liabilities that are not on the blockchain, which means there may be no visibility into their assets. not digital.
US regulators face growing pressure to force compliant crypto companies with investor protection laws. The SEC, under Chairman Gary Gensler, has pledged to crack down on the crypto market and called for more exchanges to register with the regulator, but has not directly commented on the use by reserves proof platforms.
In March, the regulator told companies that report to the SEC, including cryptocurrency exchanges, disclose digital tokens they hold for customers on their balance sheets. Companies have complied since it came into force in June.
Coinbase Global Inc.
last month, crypto assets and liabilities for clients were $95.11 billion for the quarter ended Sept. 30, up from $88.45 billion in the prior quarter, according to filings. The SEC declined to comment.
The SEC’s audit watchdog, the Public Company Accounting Oversight Board, cannot inspect the audits of private crypto companies, such as BlockFi Inc. and FTX, both of which recently filed for bankruptcy. Still, the PCAOB encourages investors to review reports on the work performed by auditors at these companies, Chair Erica Williams said at a conference on Tuesday.
Proof of reserves will likely become more popular among crypto firms in the coming months, in part to maintain customer confidence, said Campbell Harvey, a professor of finance at Duke University.
“They are desperate to do something because the level of trust has dropped,” he said. “Right now the level of opacity is unacceptable so they have to do something and it’s something they can do.”
Write to Mark Maurer at email@example.com
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