Welcome to the seventh Market Scan from the IAASB’s Disruptive Technology team. Building on our ongoing work, we will issue a Market Scan every 2-3 months. Market Scans cover exciting trends, including new developments, corporate and start-up innovation, noteworthy investments and what it all might mean for the IAASB.

In this Market Scan, we explore Digital Assets, with a focus on recent developments within the Cryptocurrency market and what it might mean for the audit and assurance ecosystem. Future Market Scans will build on this area by focusing on related technologies, such as blockchain and smart contracts.

Technology Landscape, September 2022

We cover:

  • What are digital assets and why are they important?
  • The latest developments
  • What this might mean for the IAASB

What Are Digital Assets and Why Are They Important?

A digital asset is anything that exists in digital form only, has or provides value, is identifiable and discoverable, and is associated with ownership or use rights. Types of digital asset include cryptocurrencies and non-fungible tokens (NFTs) as well as digital content like photos, audio files, videos, websites, presentations, spreadsheets, or text files.

Cryptocurrencies (or crypto-assets) such as Bitcoin, Ethereum and Solana use blockchain technology, a distributed ledger that is a computerized database using strong cryptography to secure transaction records, control the creation of additional coins, and verify the transfer of coin ownership. Using this decentralized approach eliminates the need for traditional intermediaries, such as banks, to enable funds to be transferred between two parties. Cryptocurrencies can be bought and sold using accounts with cryptocurrency exchange platforms (e.g., Coinbase, Crypto.com) or through a standalone digital wallet.

Stablecoins are a type of cryptocurrency whose value is pegged to that of another currency, commodity or financial instrument. Stablecoins seek to offer price stability by maintaining reserve assets as collateral or through algorithmic formulas designed to control supply. Examples of stablecoins include Tether, USD Coin and TerraUSD.

Cryptocurrency coins are native to their own blockchain (e.g., Ether on the Ethereum blockchain) and are mainly used for payments, investments and trading.

Cryptocurrency tokens have many uses, such as for buying products (transactional tokens), representing ownership (security tokens), conferring voting rights (governance tokens), accessing services (utility tokens) or supporting decentralized applications on the blockchain (platform tokens).

Coins vs Tokens: What’s the Difference? Three-minute watch, Coin Gecko

The advantages of cryptocurrencies include less expensive and faster money transfers and decentralized systems that are not reliant on a central intermediary. Disadvantages of cryptocurrencies include their price volatility, high energy consumption for mining activities (where proof of work is the consensus mechanism used to confirm values on the blockchain) and how easy it is to use crypto for criminal activities.

From an audit and assurance perspective, there is an ever-increasing likelihood that audited entities may be engaged in digital asset related activities, such as holding, transacting or using digital assets; facilitating trading of digital assets on customers’ behalf; or creating digital assets for sale or distribution to third parties. These activities may have unique risks of material misstatement that need to be understood and appropriately addressed as part of a financial statement audit. For example, where digital assets are held by third parties (such as trading platforms or other custodians), obtaining an understanding of the material custodial arrangements and relevant controls related to safeguarding and maintaining records of those assets may be appropriate.

In its Inspections Insights publication in November 2019, the Canadian Public Accountability Board noted certain recurring findings in its inspections of audit files of reporting issuers with activities in the crypto-asset sector. Areas for improvement included:

  • Obtaining an adequate understanding of audit risks when designing the audit approach;
  • Evaluating the reliability of information to be used as audit evidence obtained from crypto-exchanges and custodians, as well as from blockchains;
  • Obtaining sufficient evidence to support an entity’s ownership claims to self-custodied crypto-assets; and
  • Performing procedures in addition to vouching crypto-assets received to the blockchain, for entities engaged in crypto-asset mining activities.

A follow-up publication in August 2022, Auditing in the Crypto-Asset Sector, highlighted considerations for auditors when auditing the financial statements of reporting issuers that use custodians to safeguard their crypto-assets.

Recent Noteworthy Developments in Digital Assets

These recent developments may signal ongoing or future disruption in this area. It is not a complete list of all activities related to digital assets.

1.  The Crypto Winter

FTX Empire Goes Bankrupt in Sudden Fall of Bankman-Fried | Bloomberg Law – The collapse of cryptocurrency exchange FTX in November 2022 was the most significant in a series of company failures that hit the cryptocurrency industry in 2022.

How Terra’s UST and LUNA Imploded |Decrypt – In May 2022, Terra’s UST stablecoin and governance token LUNA collapsed, sending shockwaves through the cryptocurrency market and leading to the fall in price of Bitcoin and other cryptocurrencies as investors started to pull their investments. This in turn led to crypto hedge fund Three Arrows Capital falling into liquidation and affected cryptocurrency lenders, including Voyager Digital, Celsius Network and BlockFi, which all subsequently filed for bankruptcy protection.

US regulators warn banks over cryptocurrency risks | BBC News – In January 2023, US regulators issued a joint warning to banks over the risks associated with the cryptocurrency market.

The Global Digital Assets and Cryptocurrency Association, a global self-regulatory association for the digital asset and cryptocurrency industry published an open letter calling for agreement on a set of fundamental core principles for the industry, including appropriate customer protection, governance and risk management procedures.

2.     Crypto audits under scrutiny

Crypto Exchanges’ A La Carte Approach To Audits A Recipe For Disaster | MSN – A Forbes survey of the world’s largest cryptocurrency exchanges highlighted that not all are subject to full financial statement audits. The article noted that, “depending on where they are based, cryptocurrency exchanges do not have to submit to audits. If they do, their financial statements can remain private or be shared only with regulators. This is in stark contrast to issuers of publicly traded securities in major developed markets whose accounts must be regularly audited and made public.”

SEC Increases Scrutiny of Audits of Cryptocurrency Companies | WSJ – In the wake of the FTX collapse, a number of cryptocurrency exchanges sought to reassure investors by providing transparency reports or proof of reserves information, some of which had been subject to agreed-upon procedures (AUP) reporting by an independent auditor. However, the US Securities and Exchange Commission (SEC) raised concerns about investors placing too much confidence on the reporting, which Paul Munter, the SEC’s chief accountant, said, “is not enough information for an investor to assess whether the company has sufficient assets to cover its liabilities.” Several audit firms have stopped providing proof-of-reserves work in light of concerns over investor overreliance and reputational risk.

What This Might Mean for the IAASB

The IAASB is interested in maintaining its collective knowledgebase on digital technologies (including on specific sub-topics such as digital assets), promoting digital readiness and enablement through its engagement with stakeholders, and encouraging action by others to supplement and support the IAASB’s standard-setting activities.

Subject to the IAASB’s work plan decisions, possible digital technologies use cases for audited entities and audit or AUP engagements might provide input for further modernizing the IAASB’s standards so they are adaptable to and reflect the current business and audit environment, while remaining principles-based.

Despite the turbulence in the digital asset and cryptocurrency industry over the last year, there continues to be more than 300 million individual cryptocurrency users and approximately 18,000 businesses accepting crypto payments. The corporate failures experienced in this industry bring into focus audit’s important role in enhancing confidence in financial statements, thereby contributing to capital markets’ effective functioning and stability. In addition, it highlights the need for a consistent approach to financial reporting by, and regulation of, entities in the industry. Building suitable skills and expertise in this increasingly complex area is also necessary to enable audit and assurance professionals to act appropriately.

As this space evolves, the IAASB may need to consider how best to highlight the application of its principles-based standards in providing audit, assurance or related services to businesses operating in the digital asset ecosystem, including facilitating and supporting actions by others (e.g., in developing non-authoritative guidance).

Useful Articles and Resources

Interesting story

Sales from the crypto: Muse NFT album to become first new chart-eligible format in seven years | The Guardian, three-minute read

British rock band Muse released their ninth studio album, Will of the People, in NFT form in August 2022 and it became the first NFT album to reach number 1 in the music charts.