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Following the collapse of FTX, crypto exchanges experienced bank runs of varying degrees. Some even went bankrupt. During those days, CZ targeted many exchanges directly and stated that he would voice his objections to all suspicious activities. In this process, all exchanges sought various ways to prove their reliability. Creating audit reports was one of them.
SEC’s Crypto Warning
Paul Munter, the SEC‘s chief advisor on accounting and auditing matters, wrote in a statement that crypto companies market their relationships with accounting firms as auditors, even though their work does not fully comply with this definition.
Munter points out that the Public Company Accounting Oversight Board’s (PCAOB) “reserve reports are inherently limited” and that customers should be extremely cautious when relying on them to conclude that there are sufficient assets to meet customer obligations.
It seems that the SEC will put pressure on crypto companies claiming that “reserve evidence” reports are financial statement audits.
“As accounting firms increasingly engage in such non-audit work, they become complicit in exchanges’ marketing strategies. Non-audit regulations are neither as thorough nor as comprehensive as a financial statement audit and may not provide investors with reasonable assurance.”
Are Crypto Exchanges Safe?
In December 2022, Binance, KuCoin, and Cryptocom canceled their agreements with international audit firm Mazars Group after initially entering into them. According to Bloomberg, the company suspended its services due to “indications that the markets were not secured by ‘reserve evidence’ reports published so far.”
Armanino failed to predict the bankruptcy of the crypto exchange it audited. The audit firm faced collective lawsuits at the end of last year for failing to identify or detect the irregularities that led to the collapse. Since then, Armaino has ceased offering crypto audits, and its customers Kraken, Nexo, and CoinShares have had to find other auditors.
FTX’s collapse created pressure for a sector-wide movement towards “reserve evidence” and financial audits. What audit firms did at the end of last year was to check the existence of assets by examining crypto wallets. However, for a comprehensive audit, the financial statements of the relevant crypto exchange should also be thoroughly examined. This is because a billion-dollar debt of X exchange, which holds customer assets in the wallet at a 1:1 ratio, could pose a risk. For example, operating expenses may exceed the surplus balances in reserves. From this perspective, the SEC’s statement does not involve negative discrimination. It seems necessary for exchanges to provide the necessary transparency in order for investors to feel secure.
