By George Ward
Varied Approaches To Financial Audits
In the corporate finance sector, it is common for large establishments to have regular financial health checks. These audits ensure that everything, including money and debts, is appropriately recorded in the company’s reports.
They help firms determine whether their operations are in good shape, well-managed, and free of financial problems. Typically, these audits are performed by experts who don’t have any association with the firm.
They are hired to ensure that the results are fair and honest, devoid of individual or group sentiments. However, crypto establishments sometimes follow different rules regarding how frequently they are audited or who does the checking.
For example, Binance, the prominent crypto exchange, has an overall evaluation of $50.9 billion per an audit check by leading auditing firm, Mazars in November 2022. Since then, the crypto firm has consistently shared the monthly data on its cash reserves.
However, Binance has been performing the checks internally since January 2022. With the release of the report for each check, the exchange demonstrated that it had more than enough liquidity to cover its debts.
Likewise, Coinbase, the leading US-based crypto company, gets its reserves audited by outside experts every three months. They also file a complete financial report with the Securities and Exchange Commission (SEC) every February.
Hence, crypto exchanges follow a different path from traditional financial institutions in publishing their proof of reserves.
Are Crypto Auditing Firms Trustworthy?
Meanwhile, the FTX meltdown had a spillover effect on the industry as it increased the pressure on crypto exchanges. Surprisingly, auditing firms like Mazars and Armanino LLP, well-known among crypto entities, ceased to provide audit services to the industry players.
It is worth noting that both of these audit firms have had their fair share of notable cases. Armanino LLP, the 19th largest public accounting firm in the United States in terms of revenue, audited the US division of FTX.
Interestingly, Armanino LLP issued a clean bill of health to FTX. However, FTX collapsed a year after the audit due to poor management and lack of liquidity.
In 2021, Armanino LLP also issued a report for another crypto lender, Nexo, confirming that all of its debts were fully backed. However, law enforcement swung in to investigate Nexo, suspecting that the crypto lender is involved in organized crime, including money laundering and tax fraud.
Mazars, another accounting firm that worked with big names like Binance, Crypto.com, and KuCoin, also stopped serving clients in the digital asset industry following the FTX collapse last December.
Limitations Of PoR Audits
When a company’s audit does not involve an independent third party, it often leads to doubts about fairness, the credibility of the result, and the possibility of internal conflicts of interest regarding such a firm’s financial records.
In the conventional space, trust is primarily rooted in institutions. Traditional finance platforms typically lack alternatives like using cryptographic proof to demonstrate asset ownership to an external party.
However, in the crypto landscape, the situation is different. Hence, it is no surprise that many crypto firms are using Merkle Tree to ensure that their custody assets match their customers’ deposits. One primary attribute of this tool is that it enables the verification of large data sets.
While Merkle Tree Proof of Reserves (PoR) supporters believe it can replace traditional financial audits, it also requires a similar comprehensive verification level as conventional audits. Another point of contention is whether a Merkle Tree Proof of Reserves (PoR) should include an exchange’s liabilities, like debts and other financial requirements.
Analysts believe these factors are critical in determining a company’s solvency and the ability to meet customer withdrawal requests and other financial obligations. Nevertheless, recent developments indicate that PoR audits don’t necessarily prove that a crypto firm has sufficient liquidity.