Amid the ongoing cryptocurrency boom and bust, the emerging technology has been subject to a fair share of scrutiny. The revolutionary yet disruptive nature of blockchain garners mixed reactions from all around the globe. On one end, the Republic of El Salvador passed a legislation back in June 2021 that would officially recognize Bitcoin as legal tender, making history in the process. On the other hand, China’s on-going crackdown on virtual currencies only serves to signal the eventual ban on anything crypto-related in Mainland.
The urgent need to establish cryptocurrency’s regulatory environment highlights its rapid pace of adoption within the global financial sector. As these digital assets in companies’ financial statements become commonplace, challenges pertaining to the audit treatment of such assets will naturally arise. In such an ever-changing regulatory environment, what should an auditor do?
To begin with, an auditor’s fundamental objectives lie in reassuring stakeholders that a company’s operations is transparent enough to dispel doubts as well as presenting their financial statements in a way that is fair and free of material misstatements. In the context of cryptocurrencies, the lack of official guidelines to impose consistent regulation make the audit process extremely challenging.
Generally speaking, several key issues need to be addressed regarding the asset itself and its related transactions:
Does the asset exist?
Who holds ownership of the asset?
Have all transactions been properly documented?
Is there sufficient evidence to prove the authenticity and legitimacy of transactions?
Have all appropriate disclosures been made?
Along with these standard audit questions, the complex environment of digital assets also introduces new issues that complicate the process. It starts from an individual cryptoasset’s inherent classification to the underlying blockchain architecture supporting it.
Native cryptocurrencies (e.g., Bitcoin-BTC and Ethereum-ETH) possess intrinsic value that are very hard to ascertain. In fact, many would argue they have none. Over time however, cryptocurrencies have diverged into more complex entities that possess intrinsic value. Two such examples are asset-backed cryptocurrencies and stablecoins.
Asset-backed cryptocurrencies are tokens which have values pegged to physical assets such as commodities including gold and real estates. One example is Tether Gold (XAUT), where each token represents ownership of one troy ounce of physical gold. Stablecoins such as the USD Coin (USDC), on the other hand, are a form of cryptocurrency pegged to its fiat counterpart. In such cases, auditors have to consider and assess the extent of risk that the associated asset brings into the equation.
In terms of the blockchain framework for a specific cryptocurrency, an auditor must consider the presence and impact of any smart contracts — programmable logic that automates the execution of transactions as per its written code. The implementation of such codes may pose additional security/competency-related risks that can endanger the system as a whole which should not be taken lightly.
With that said, the intricate nature of a crypto asset audit serves to urge the professional services industry to establish appropriate standards as the emerging asset class creeps into the mainstream. Likewise, auditors have to stay sharp, applying their expertise to actively engage in the development of analytics and methodologies to streamline the crypto asset audit process in the foreseeable future.
As the accounting and audit rules on cryptos are constantly evolving, interested parties are best to consult the experts at Normsun CPA. for the latest development in Hong Kong and around the globe.
Written by: Leonardo Liu, Dr. Kyle Wong
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