Crypto Audit: The Need, Types (Financial, Tangible, Intangible),…

Summary: Crypto auditing is a crucial aspect of ensuring transparency and sustainable growth in the cryptocurrency market. Audits help verify the true value of Crypto companies, build investor confidence, and contribute to reducing fraudulent activities.

Why is Crypto auditing necessary?

The Crypto market is growing rapidly, attracting the attention of many investors. However, this growth also harbors many risks, particularly regarding transparency.

People often ask: “How can we know the true value of a Crypto company? How can we be sure they actually own the assets they claim to possess?”

Crypto auditing provides the answer to these questions. Similar to audits of companies listed on stock exchanges, Crypto auditing helps determine the value of tangible and intangible assets of a Crypto company.

• Note: For companies already listed on stock exchanges, their token capitalization is not equivalent to and does not represent the value of the enterprise. The reason is that each share already represents the value of the company. Shareholders owning shares essentially own the company. If we include token capitalization, it would be a double count, doubling the actual value. Therefore, [token capitalization = company value] is incorrect for companies already listed on stock exchanges.

1. Role of third-party – necessity for any business

Independent third parties, such as auditors, play a crucial role in evaluating and verifying information from Crypto companies. They can:

• Review records: Examine records and documents provided by the Crypto company.
• Blockchain verification: Verify transactions on the blockchain, using tools like Ethereum Explorer, BSC Explorer, etc., to check if transactions are legitimate and data is accurate.
• Risk assessment: Identify, assess, and mitigate risks associated with the operations of the Crypto company.

2. Role of auditing for investors

• Valuation: Help investors value tokens by valuing related businesses based on transparent and reliable information (blockchain can be leveraged for this).
• Investment risk: Help investors assess investment risks in crypto-related companies, choosing projects with potential and credibility. Audits help reduce the number of investments in low-profit, loss-making projects, while also avoiding cases of rug pulls, money grabs, and running away with funds.

3. Role of auditing for exchanges

• Proof of reserves: Large exchanges like Binance, OKX, and MEXC need to prove their reserves to ensure sufficient funds to cover customer transactions, building trust among traders. Since these traders deposit fiat and crypto assets into the exchange, the exchange holds these assets. Therefore, they must ensure they have enough funds to match deposits or, at the very least, enough liquidity to pay out when traders withdraw large amounts.
• Minimizing exchange crashes: Audits help bring transparency to exchange assets, reducing the risk of exchange crashes when users withdraw funds en masse, as happened with FTX in 2022.

Examples of asset transparency:

• Binance: Binance regularly publishes reports proving asset reserves, confirming they hold enough assets to pay customers.
• OKX: Similar to Binance, OKX also publishes reports proving asset reserves.
• MEXC: MEXC has also implemented asset transparency mechanisms to enhance investor confidence.
• Tether: Tether is the largest stablecoin in the market, and they also frequently publish reports proving their asset reserves to ensure the value of USDT remains equivalent to the value of the USD.
• USDC, cUSD: Other stablecoins, like Circle’s USDC and Celo’s cUSD, also have similar asset transparency mechanisms to Tether.

Overall, the benefits of auditing in the Crypto market:

• Increased transparency: Helps investors understand the true value of Crypto companies.
• Building trust: Enhances investor confidence in the Crypto market, encouraging investment and development.
• Fraud prevention: Helps detect and prevent fraud in the Crypto market, preventing rug pulls, money grabs, and protecting investor rights.
• Sustainable development: Contributes to the sustainable growth of the Crypto market, laying the foundation for strong and stable market development.

What does Crypto auditing focus on?

According to Click Digital, in terms of audits, besides technology, Crypto audits typically focus on financial audits. This financial auditing is quite similar to that of companies on stock exchanges, including:

1. Asset auditing

Intangible assets in the Crypto market may include:

• Leasehold rights: Rights to use land for a specific period, often used in real estate or rental projects.
• Issuance rights: Rights to issue products, services, or tokens.
• Brand names: Logo, brand, name of the product/service/project.
• Computer software: Software developed and used for blockchain applications, exchanges, or other projects.
• Licenses and franchises: Operating licenses, business franchises in the blockchain industry.
• Copyrights and patents: Copyrights, patents for technologies, products, solutions related to blockchain.
• Formulas, methods, models, designs, and prototypes: Business secrets, production technology, source code architecture.
• Inventions, patents, copyrights…: Intellectual property protection for inventions related to blockchain.

Tangible assets in the Crypto market may include:

• Buildings, structures: Offices, company headquarters.
• Machinery, equipment: Machinery used for mining, storing, and processing data.
• Means of transport: Cars, motorcycles used for company operations.

Crypto companies often have assets concentrated in intangible assets. Intangible assets in the Crypto market are diverse and complex, requiring auditors with specific expertise in this market to properly assess their value.

2. Business activity auditing

• Revenue: Determine the source, calculation method, and reasonableness of revenue, including transaction fees, revenue from product/service sales, investment income, etc.
• Expenses: Check the reasonableness of incurred expenses, including personnel costs, development costs, marketing costs, security costs, etc.
• Profit: Assess the reasonableness of profits recorded by the Crypto company, including profit margin, profit after tax, etc.
• Cash flow: Check the cash flow from the company’s business activities, including operating cash flow, investment cash flow, and financial cash flow.

3. Compliance auditing with ethical and legal standards

• Financial regulations: Check if the Crypto company complies with tax regulations, accounting laws, asset management regulations, etc.
• Anti-money laundering: Check if the Crypto company implements KYC/KYT, complies with anti-money laundering regulations, and prevents the financing of terrorism.
• Data security: Check if the Crypto company complies with regulations on personal data and financial data security, has secure security measures, and prevents cyberattacks.

Conclusion

Crypto auditing is a crucial aspect of ensuring transparency and sustainable growth in the cryptocurrency market. Having a reputable and independent auditor helps build investor confidence, mitigate risks, and drive the growth of the Crypto market.

Note: Crypto auditing is an evolving field that requires further clear regulations and standards to ensure objectivity and effectiveness.