What's next for crypto auditors and their non-audits?

I've been consistent. I have to say I'm glad I was patient enough to see the rest of the world catch up and come around.

A little more than a week ago, Bryce Elder at The Financial Times documented a timeline of the discussion about auditors and crypto that went all the way back to August 2014 and the days when the former Bloomberg programmer Changpeng “CZ” Zhao was chief technology officer at OKCoin, a start-up Chinese token exchange:

In August 2014, a few months before CZ left, OKCoin published what it called the industry’s “first Proof-of-Reserves Audit”. The report was written by Stefan Thomas, who at the time was CTO of crypto payments group Ripple and was well known to the community. He concluded (with numerous caveats) that bitcoin balances appeared to cover user funds by more than 104 per cent.

Calling this an audit was unhelpful because it wasn't.

It was unhelpful again when "CZ" called what audit firm Mazars did for his new offshore firm, Binance, the purported largest crypto exchange, an audit.

I've been saying this since 2017. 

I only go back five years because, as I wrote in February 2022, I really wanted to avoid having to write about crypto.

But this 500-pound black bear is eating everything! We can’t continue saying, “Let’s just ignore him as long as he doesn’t attack anyone.”

In June 2018, Marc Hochstein wrote at Coindesk about the first time Tether had produced a third-party report to reassure everyone that its stablecoin, USDT, was fully backed by U.S. dollars.  However, there were some big caveats then, as there still are now.

First, Tether had parted ways with an actual audit firm in January 2018 that had been working on an audit.  

Tether, the issuer of the dollar-pegged cryptocurrency USDT, said its relationship with audit firm Friedman LLP has ended.

The statement, provided Saturday evening by a company spokesperson to CoinDesk, confirms the suspicions of online sleuths and is likely to raise new questions about the company's finances.

Friedman had been working on an audit of Tether, which has close ties to the cryptocurrency exchange Bitfinex.

(In September, Friedman LLP, the New York-based accounting firm that had provided auditing services for the stablecoin issuer Tether in 2017 was accused of “serial violations of the federal securities laws” and “improper professional conduct,” by the U.S. Securities and Exchange Commission, which fined the auditor $1 million. Friedman LP merged with SPAC, microcap, and barred from auditing China companies Marcum LLP in Sept 2022. )

Second, the firm that succeeded Friedman did not produce an audit report because it was a law firm.

Third, the report was not an audit. It was prepared by a law firm – Freeh Sporkin & Sullivan, LLP (FSS) – not an accounting firm. 

Fourth, even Tether's general counsel said that getting an audit was not easy.

"The bottom line is that an audit cannot be obtained," [Stu] Hoegner [ Tether's general counsel] told CoinDesk, claiming that this problem is not unique to his company but one faced by the entire cryptocurrency industry. "The barriers to getting audited are simply too big to overcome right now, and not just for us."

Two professionals I hold in high regard, Mike Shaub and Tom Selling, were quoted in that 2018 article.

Indeed, a law firm's report is unlikely to carry as much weight as an audit firm's would, and not only because of the obvious difference in skill sets.

That's because, at least under U.S. law, audit firms also are generally accountable not only to their clients but to third parties whose decisions rely on their integrity.

"Auditors tend to be broadly liable more frequently than attorneys do with the reports they issue," said Michael K. Shaub, an accounting professor at the Mays Business School at Texas A&M University.

Tom Selling, a CPA and former academic fellow in the chief accountant's office at the Securities and Exchange Commission, said that auditors "have specific standards for independence they have to adhere to," whereas when lawyers say they are conducting "independent" investigations for companies, "nobody knows what that means."

Put differently, "99 percent of the work a law firm does is advocacy for the client," whereas "100 percent of the work of an accounting firm is to hold themselves out as independent," Selling said.