Nicholas Newman - Harris & Trotter LLP on how the crypto industry can mature!
Published on April 12, 2023
How can the crypto industry mature? In one word: Audit
Tal Zackon and Nicholas Newman
April 11, 2023
In partnership with Harris & Trotter LLP
The crypto industry is facing several challenges, including increased regulation, bank failures, and a lack of transparency. Read how you can work with a crypto-native audit firm and build an internal database.
Think like an ecosystem
The crypto industry has recently faced several challenges, including the fallout from FTX, bank runs on Silicon Valley Bank and Signature Bank, the impact of the failure of Credit Suisse, increased regulation and scrutiny from the SEC, and other risks.
With the failure of the banking industry however, less than 15 years after the crash of 2008, this is an incredible opportunity to develop the crypto ecosystem and show that our money can be decentralized, and controlled by no one.
Now is the time to think like a mature ecosystem, prioritize compliance and risk management and bring confidence to the mass audience.
To do so, organizations must invest in their finance teams, support them, and listen to their advice.
Finance directors must take an active role in managing treasury, guiding the company’s leadership, building back office processes, and ensuring that capital is not fully locked into market risk.
Joel Haft, Head of Internal Audit at Bequant explains, “As an emerging asset class in its early stages, businesses in the digital asset space need to be risk and control-savvy, just as they would in any other financial institution.
Building out an effective second and third line of defense is on many business radars, but what does this actually mean?
In layman's terms, if anything slips through the net, whether it be internal fraud, a regulatory or data breach, for instance, the intention is that the second line (Risk & Compliance functions) will pick this up and work with the business to fix the issue at hand. Should the issue not be identified by the second line, the third line (Internal Audit) sits as an independent function assuring the internal control environment and will hopefully pick up the rest!
Having a robust set of internal controls is paramount to mitigating key risks and helps management seek comfort that, as a business, they are doing the right thing. However, for crypto firms, there is an even greater onus given the lack of transparency, growing distrust, and our current position on the maturity scale.”
However, this advice can only be effective if based on sound financial reports.
Accurate historic financials are necessary for accurate cash flow forecasting and modelling.
Similarly, banking relationships can only be developed if financial statements can be produced, and organizations can only raise debt/equity if their finance teams can survive audits.
Why is audit and reporting so difficult when it comes to crypto?
- Decentralization - Cryptocurrencies are designed to be decentralized, which means that there is no central authority or organization that controls the network.
This makes it difficult to trace transactions and identify the parties involved in a particular transaction.Companies can mitigate anonymization by building an internal database of 3rd party addresses and keep track of unidentified addresses.
- Complexity - Cryptocurrencies are highly complex systems that require a high level of technical expertise to understand.
Auditors need to be familiar with the underlying technology and understand how the blockchain works to be able to identify potential vulnerabilities and risks.
We highly recommend working with a crypto-native audit firm that understands the ins and outs of the crypto ecosystem. Choose a partner that is familiar with the activity you are more focused on if it’s DeFi or NFTs or even day trading.
- Technology - Besides knowing data, you need to understand the technology - how networks work, what is the purpose of the smart contract and how to analyze different functions.As the new layer 1s and 2s, in addition to other data sources, are gaining adoption and evolving, companies will need to adapt and develop new techniques to effectively audit the crypto data.
Tres Finance is the first Web3 financial data lake. Partnering with Harris & Trotter, we have the technology and the audit expertise to give you 100% coverage of your audit needs and always be on the lookout for new assets and transactions.
Let’s be practical!
To effectively manage and mitigate risks in the crypto industry, organizations should consider implementing the following measures:
- Invest in the latest bookkeeping software that can account for on-chain transactions.
- Hire bookkeepers who have real-world experience in accounting for high-volume crypto organizations
- Appoint internal auditors to review systems, controls, and processes to avoid repeating scandals like the FTX incident.
- Appoint auditors who have a deep understanding of on-chain transactions and the technology to actively audit and question your company. Auditors should be selected based on their quality, not just their brand.