About the Panelists

The first panel of the afternoon, “Digital Assets/Cryptocurrency,” focused on what auditors need to know about these interrelated cutting-edge technologies. The panel consisted of Michael Gonzales, partner, EY; Sean Prince, 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 speakers’ own views, 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, Deloitte. She asked Jamiel Sheikh, founder, Scifn, about the current state of the crypto space. Although he noted that there continues to be a compressed boom-bust cycle in the digital asset space, “certain use cases, certain trends are emerging. … The ability to move dollars instantly through stable coins is becoming an important use case.”

“We’ve also had negative news in the digital asset space,” Steele said. “We saw Sam Bankman-Fried convicted of fraud, and the collapse of FTX … We’ve also seen a lot of regulators speak up, both in the enforcement side, but also in potential new bills.”

An Emerging Regulatory Landscape

“Part of the evolution of the space is a call for more clear and comprehensive regulation,” said Michael Gonzales, partner, EY. He noted examples around the world and said that “here in the U.S., it’s about making sure that a stable coin issuer that has said, ‘I’m going to create a token, and I’m going to take U.S. dollars in, I’m going to put those into safe investments, whether cash at banks or U.S. treasuries, and I’m going to have enough of those assets to back up every token that I’ve issued.’ If you’re doing this particular type of activity and you’re making such assertions to your customers, it lends itself really well to a regulatory framework that says, ‘Are you doing what you say you’re doing?’”

Gonzales noted different forms of regulation might be needed for stable coins with different designs. He gave the example that there has been in New York, for more than one year, regulation from the New York DFS of reserve-backed stable coins. “I think at the federal level, there’s been recognition that that this framework seems to make a lot of sense.”

“The digital asset working group at the AICPA has been working on a set of criteria for execution of third-party attestation engagements reports that basically say, ‘Yes, the assets are there as of a particular balance sheet date, and they’re equal to, or in excess of, the issued tokens on the block-chain,’” Gonzales explained. “The other type of attestation, or third-party report that’s been talked about is called ‘proof of reserves.’ That’s the term of art that’s taken hold in the industry; personally, I don’t like it. I think it kind of puts the cart before the horse.”

Gonzales thinks that retail participants are interested in knowing whether their crypto provider is making valid assertions; the question is how to prove this. “That’s where I think some of the confusion in terminology comes up: What is a custody attestation? Is that an audit? And the word ‘audit’ will start to get thrown around, and you’ll start to create some expectation gaps, whether intentionally or unintentionally.” He noted that there is state-level legislation requiring some kind of custody attestation, and federal legislators are asking whether this makes sense in a federal framework.

“Part of the evolution of the space is a call for more clear and comprehensive regulation.”

—Michael Gonzales

Sean Prince, partner, Crowe, observed that as the digital asset ecosystem evolves, use cases become clearer, and it becomes a question of client acceptance for firms. “It’s very important for the clients we accept in this space to understand which regulatory frameworks, which regulations, and which regulators affect their organization.”

Steele stepped back to ask just what “proof of reserves” are. Sheikh said that “the central question that proof of reserve tries 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 show that the assets that are on the blockchain are sufficient to meet the liabilities that may be existing in a centralized entity or in a bank account. The mechanics of it are slightly technical, but I do believe every auditor and every accountant needs to understand the mechanics of it, because there is a bleeding now between technology and business.”

Gonzales added that it is worth highlighting what institutional investors have done in terms of holding their institutional custodians to account. “One of the things that we’ve seen over the last three or so years has been the proliferation of SOC 1 and 2 reports from institutional custodians. … The reports have been helpful in giving both the institutional investor and their auditor a window into how the institutional custodian actually works: What are their controls? How do they view different risk objectives and address those—from the cryptographic private key security to reconciling transactions and balances to the blockchain.” Gonzales noted that some institutional investors will pay a premium to have a segregated account around which they can layer their own monitoring controls; however, it is a challenge to scale this approach to smaller retail customers.

Steele turned to SAB 121, the SEC’s recent guidance regarding entities’ responsibilities to safeguard their customers’ digital assets. Prince said that practitioners had to educate themselves on the SEC’s staff’s intentions.

“What we learned quickly is it was broader than contractual obligations. We were talking about SAB 121 applying to folks who didn’t have necessarily a legal or contractual obligation to safeguard somebody else’s assets,” Prince explained. “You have to look beyond contractual legal obligations and think about the customer perception as well.”

Prince described the conversations he has had with bank clients that were considering offering their clients the opportunity to trade in crypto assets. Even if the bank were to partner with a third party to handle the technological infrastructure, if customers were to suffer losses from a hack they would hold the bank responsible. This perception would likely exist regardless of contractual obligations, and perhaps even if the bank does not have a direct line of custody of the crypto assets.

“For those entities that don’t apply the SAB, we always think about it through that contingent liability lens,” Gonzales added. “Putting it on the balance sheet may provide more technical discipline around scoping, and a few other things may be a risk. Assessment gets a bit sharper. Probably the one assertion that pops up is now you have to value it because it’s on the balance sheet. … even if you’re only a custodian that doesn’t typically transact or exchange, you have to try to get a fair value for the digital assets.”

In response to a question on valuation, Prince noted that 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 that the standard will allow for fair value measurement of holdings of certain crypto assets. “This is a situation where preparers, practitioners, and investors all agree that fair value accounting is a better answer for the holdings within the scope of the standard.” He also noted however that it will raise complicated questions about scope and valuation.

Worlds Colliding

Sheikh said he advises both large institutions and “shadowy” individual traders, and he noted that these two different worlds are colliding in a way that is becoming political. The original crypto ethos of “I will control my money—a self-sovereign currency” has led to major banks creating permissioned blockchain systems with publicly identifiable parties. “The stable coin world is coming in from out of the shadows into a regulated world, and it’s murky and unclear.”

“Then on a technical level, which will become a business problem, which will become an auditing and accounting problem, there’s these fragmented pools of liquidity growing globally,” he said. Although banks might attempt to bridge these liquidities, that will raise questions, especially in cases where the counterparty is hidden, making disclosure impossible.

“When we talk to clients, customers, central banks, regulators… everybody’s trying to figure this out,” Gonzales summed up. “Where does that take us? I think that remains to be seen.”

The discussion turned to the AICPA’s digital assets working group. Prince said the group has gotten to the low-hanging fruit, “so right now we’re spending a lot of time refreshing the Q&As to make a distinction between those that will be accounted for as an intangible asset and those that will be subject to FASB’s fair value measurement guidance. We’re also thinking about some of those items that FASB left off of their standard.” He gave the examples of RAP tokens and the transaction costs to obtain digital assets.

“This is a situation where preparers, practitioners, and investors all agree that fair value accounting is a better answer for the holdings within the scope of the standard.”

—Sean Prince

The Future of Crypto

“I think what we’ll start to see is convergence between artificial intelligence and crypto,” Sheikh said. “In a lot of ways, generative AI will possibly do what Crypto wanted it to do, in the sense that I can use generative AI to optimize my portfolio, and I then have this self-sovereign finance. … if I’m able to trade cryptos because of generative AI suggestions and signals and indicators, then maybe I’m in a different world.”

“I’m curious what the odds are that FASB will take on anything else beyond holdings of crypto assets,” Prince said. FASB is looking to do another agenda consultation, “so it’ll be interesting to see whether crypto makes the cut this time around.”

“I will say that regulatory clarity, whenever and however it comes, as well as regulatory embrace or acceptance from incumbents, will serve to underpin accelerated institutional adoption,” Gonzales said. He added that traditional finance players have been “sitting on the sidelines, waiting for clarity, and I think once it comes, they’re going to explore in earnest the use cases that Jamiel was referring to earlier.”

Steele said her 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 audit that. I’m hopeful that that dialogue and that collaboration will continue across the profession, with preparers and auditors, and audit committees and standards setters and regulators, all working together as we try and figure out how to protect investors and also recognize all the technology advances in this space.”