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Digital Assets/Cryptocurrency – The CPA Journal
Information about the panelists
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The first panel of the afternoon, “Digital Assets/Cryptocurrency,” focused on what auditors need to know about these cutting-edge, interconnected technologies. The panel consisted of Michele Gonzalespartner, EY; Sean Principe, partner, Crowe; AND Jamiel Sheikh, founder, Scifn. It was moderated by Amy Steele, partner, Deloitte. The comments and opinions expressed at the conference and reproduced here represent the opinions of the speakers and not necessarily those of their employers or affiliated institutions.
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The past few years have seen many new developments and growth in the digital asset ecosystem, began moderator Amy Steele, partner at Deloitte. She asked Jamiel Sheikh, founder of Scifn, about the current state of the crypto space. While she noted that there continues to be a compressed cycle of boom and bust in the digital asset space, “certain use cases, certain trends are emerging. … The ability to instantly move dollars through stable coins is becoming an important use case.”
“We have also had negative news in the digital assets sector,” Steele said. “We’ve seen Sam Bankman-Fried convicted for fraud and the collapse of FTX… We’ve also seen a lot of regulators speaking out, both on the enforcement side, but also about potential new laws.”
An emerging regulatory landscape
“Part of the evolution of the space is the demand for clearer and more comprehensive regulation,” said Michael Gonzales, partner at EY. He noted examples around the world and said that “here in the United States, it’s about making sure that you have a stable coin issuer that has said, ‘I’m going to create a token and I’m going to take US dollars, I’m going to put them in safe investments, whether they’re cash at banks or the US Treasury, and I will have enough of these assets to back every token I issue.’ If you do this particular type of business and make those claims to your customers, it lends itself very well to a regulatory framework that says, “Are you doing what you say you’re doing?”
Gonzales noted that different forms of regulation may be needed for stable coins with different designs. He gave the example of the fact that in New York, there has been regulation by the New York DFS of reserve-backed stablecoins for more than a year. “I think there has been recognition at the federal level that this framework seems to make a lot of sense.”
“The AICPA Digital Assets Working Group has been working on a set of criteria for running third-party attestation commitment reports that basically say, ‘Yes, the assets are there as of a particular balance sheet date and are equal to or greater than tokens issued on the blockchain,” Gonzales explained. “The other type of attestation, or third-party report that was discussed, is called ‘proof of reservations.’ This is the term of art that has taken hold in the industry; I personally don’t like it. I think it kind of puts the cart before the horse.
Gonzales believes retail participants are interested in knowing whether their cryptocurrency provider is making valid claims; the question is how to prove it. “This is where I think some terminological confusion arises: what is a custody certificate? Is it a test? And the word ‘audit’ will start to get thrown around, and you’ll start to create some gaps in expectations, whether intentionally or not.” He noted that there is state-level legislation requiring some sort of custodial attestation, and federal lawmakers question whether that makes sense in a federal framework.
“Part of the evolution of the space is the demand for clearer and more comprehensive regulation.”
—Michael Gonzales
Sean Prince, partner at Crowe, noted that as the digital asset ecosystem evolves, use cases become clearer and it becomes a question of customer acceptance by companies. “It is very important for the clients we take on in this space to understand which regulatory frameworks, which regulations and which regulators affect their organisation.”
Steele took a step back to ask what “evidence of reservations” is. Sheikh said that “the central question that the reserve test seeks to answer is: ‘Do you have enough assets to support your liabilities?’ … Proof of reserves is an attempt to bring the two worlds together to demonstrate that assets on the blockchain are sufficient to meet liabilities that might exist in a centralized entity or bank account. Its mechanics are slightly technical, but I think every auditor and every accountant needs to understand the mechanics, because now there is a hemorrhage between technology and business.”
Gonzales added that it is worth highlighting what institutional investors have done in terms of holding their institutional custodians accountable. “One of the things we’ve seen over the last three years or so is the proliferation of SOC 1 and 2 reports from institutional custodians. … The reports were helpful in providing both the institutional investor and their auditor a window into how the institutional custodian actually works: What are their controls? How they see different risk objectives and how they address them: from cryptographic private key security to reconciling transactions and balances on the blockchain.” Gonzales noted that some institutional investors will pay a premium to have a separate account around which they can layer risk own monitoring controls; however, it is a challenge to extend this approach to smaller retail customers.
Steele addressed SAB 121, the SEC’s recent guidance regarding entities’ responsibilities to safeguard their customers’ digital assets. Prince said practitioners should inquire about the SEC staff’s intentions.
“What we quickly learned was that this was a broader issue than contractual obligations. We were talking about SAB 121 applying to people who didn’t necessarily have a legal or contractual obligation to safeguard someone else’s property,” Prince explained. “You have to look beyond contractual legal obligations and also think about the customer’s perception.”
Prince described conversations he had with bank clients who were considering offering their customers the opportunity to trade cryptocurrencies. Even if the bank were to partner with a third party to manage the technology infrastructure, if customers were to suffer losses due to a cyber attack they would hold the bank responsible. This perception would likely exist regardless of contractual obligations, and perhaps even if the bank did not have a direct line of cryptocurrency custody.
“For those entities that do not apply the SAB, we always think through the lens of potential liability,” Gonzales added. “Putting it on the balance sheet can provide more technical discipline around scoping, and some other things could pose a risk. The evaluation becomes a little more precise. Probably the only statement that stands out is that you now have to value it because it’s on the balance sheet. … even if you are just a custodian who doesn’t normally transact or trade, you need to try to get fair value for digital assets.”
In response to a question about the rating, Prince noted that the FASB is expected to issue a final standard soon. [Editors’ Note: On Dec. 13, 2023, FASB issued ASU 2023-07, Intangibles—Goodwill and Other—Crypto Assets (Subtopic 350-60).] Prince said the standard will allow the measurement of the fair value of holdings in certain crypto assets. “This is a situation where preparers, practitioners and investors all agree that fair value accounting is a better answer for holdings that fall within the scope of the standard.” He also noted, however, that this will raise complex questions about scope and evaluation.
Worlds colliding
Sheikh said he advises both large institutions and individual “dark” traders, and noted that these two different worlds are colliding in a way that is becoming political. The original crypto ethos of “I will control my own money, a self-sovereign currency” led major banks to create permissioned blockchain systems with publicly identifiable parties. “The world of stable coins is emerging from the shadows into a regulated world, and it’s dark and unclear.”
“Then on a technical level, which will become a business problem, which will become an auditing and accounting problem, you have these fragmented pools of liquidity that are growing globally,” he said. While banks may attempt to fill this liquidity, this will raise questions, especially in cases where the counterparty is hidden, making disclosure impossible.
“When we talk to clients, customers, central banks, regulators… everyone is trying to figure it out,” Gonzales summed up. “Where does this leave us? I think that remains to be seen.”
The discussion moved to the AICPA’s Digital Assets Working Group. Prince said the group has arrived at a result within reach, “so right now we are spending a lot of time updating the Q&A to make a distinction between those that will be accounted for as intangible assets and those that will be subject to Guidance to FASB’s fair value measurement. We are also thinking about some of those items that FASB has excluded from its standards.” He gave the examples of RAP tokens and transaction costs for obtaining digital assets.
“This is a situation where preparers, practitioners and investors all agree that fair value accounting is a better answer for holdings that fall within the scope of the standard.”
—Sean Prince
The future of cryptocurrencies
“I think what we will start to see is the convergence of artificial intelligence and cryptocurrency,” Sheikh said. “In many ways, generative AI will probably do what Crypto wanted it to do, in the sense that I can use generative AI to optimize my portfolio and then have this self-sovereign finance. …if I am able to trade cryptocurrencies with generative AI suggestions, signals and indicators, then perhaps I am in a different world.”
“I’m curious what the odds are that FASB will take charge of something other than owning crypto assets,” Prince said. The FASB is trying to hold another consultation on the agenda, “so it will be interesting to see if cryptocurrencies can make it this time.”
“I will say that regulatory clarity, all the time, as well as regulatory adoption or acceptance by incumbents, will serve to support accelerated institutional adoption,” Gonzales said. He added that traditional financial players have been “sitting on the sidelines, waiting for clarity, and I think once it comes, they will seriously explore the use cases that Jamiel was referring to earlier.”
Steele said his final thoughts are a hope for the future: “There’s this healthy dialogue as technology advances, and we’re learning a new thing every day and trying to figure out how we can test that. I hope that that dialogue and collaboration continues throughout the profession, with preparers, auditors, audit committees, standard setters and regulators, all working together as we try to figure out how to protect investors and also recognize all the technological advances in this space.”