Audit? I Hardly Even Tokenized It!
Why audits and attestations will prove to be important in the cryptocurrency space for exchanges, ICOs, and stablecoins.
Many in the cryptocurrency space are young and bold and ready to ejaculate their tokenized ideas onto the “new paradigm.” That’s fine, of course, as most will fail so hard they’ll go unnoticed. But some won’t, and already have succeeded past the point of, “no one gets hurt.” I speak little ill-will toward the “successfully decentralized” coins like Bitcoin, Bitcoin Cash, and (I guess?) Ethereum, but instead, I speak of the thousands of ICOs, IEOs, exchanges, and stablecoins that have accumulated since the previous bull market.
The GFY Economy
Bitcoiners generally live and die by two turns of phrase:
“Don’t trust, verify.”
“Not your keys, not your coins.”
These are simplistic concepts and boil down the coiner philosophy correctly — but there are some underlying facts that lay in the undisclosed details. Bitcoin relies entirely on its speculative value. If it were to acquire that value from P2P transactions without a third-party, it would need to be used regularly and often by many people for payments and transactions for goods and services. Needless to say, this is not the case.
In the absence of a reliable, large market to ascertain the notional value of the underlying asset, by necessity one ends up relying on third parties to conduct price discovery. As of today (and the immediate future), that price discovery is primarily conducted on exchanges and options trading platforms for Bitcoin and other cryptocurrencies, which instantly introduces counter-party risk.
If one is repeatedly advised not to store one's coins on an exchange, but has nowhere to spend one's coins, and also hopes the speculative value of one's asset will increase, what exactly is one to do?
What we end up doing is working within the framework currently provided — and that framework is buying and selling through trusted third parties. Few of these exchanges, ICOs, IEOs, and stablecoins actually abide by any sort of real attestations or auditing, few conduct themselves transparently, and only a handful go out of the way to absolve themselves from possible future regulatory capture.
Of course, it’s easy to throw caution to the wind and trudge on with the mindset, “If we’re all breaking the law, then the law can’t stop anyone.” However, not only is this inaccurate, but it also fails to hold private entities accountable to their customers and fails to prove that these entities are above board with their actions toward the community at-large.
Yeah, right. The fact of the matter is there are a handful of actors controlling almost all of the volume for Bitcoin and other cryptocurrencies: BitMex, Bitfinex, Binance, and to a lesser degree, Coinbase, and one token that’s traded against almost all cryptocurrencies, shifting money from Bitcoin and Bitcoin forks to shitcoins and back again — Tether.
None of the entities named above provide any real insight into their operations. For instance, after being hacked in 2016, Bitfinex promised a security and financial audit. Neither came to fruition.
BitMex resides in the most expensive building in Hong Kong, is incorporated in Seychelles, and regularly collapses when inundated with orders. Do they trade against customers? Is there wash trading? ¯\_(ツ)_/¯
Even if I wanted to, there’d be no way to name all the red flags from all the exchanges and coins out there — recent ones include the Bitfinex LEO IEO, which claimed a billion in sales with zero proof, Tether, which consistently promised an audit/attestation, then reneged, and Coinbase, which seems prone to insider trading every time it considers listing a coin.
A New Problem Is The Same Old Problem
Now, the peer-to-peer, unstoppable, decentralized, whatever you call it realm, goes completely unchecked and is utterly unbalanced. The best way to see if your biggest players are truthful or dishonest? Bring in a “trusted, objective” third-party to look at the books and determine if everything is acceptable.
“But, Cas!” I hear the coiners cry, “I specifically got into this space to avoid trusting third parties and fourth parties!”
My response is a hearty, “l-o-l.”
It’s time for coiners to get on board with demanding transparency from those who control the volumes and the majority of coins, and this will require the expertise of accounting, cryptographic, and financial professionals and an open, honest dialogue with customers.
There’s a reason that many write-off the importance of audits and attestations: Enron’s downfall was aided by the terrible, delusional accounting practices of Arthur Andersen — one of the supposed “Big Eight” auditing firms at the time. With the collapse of Enron came to the collapse of Arthur Andersen, as well, and the Big Eight have been whittled down to the “Big Four.”
The Big Four have the incentive to lie for their clients — their clients being the largest corporations in the world — because they want to retain them and their large paychecks. I have previously discussed accounting and its flaws in my piece on WorldCom, which you can read here. The underlying recommendation from Cynthia Cooper appeared to be that internal auditors should have more independence from their respective corporations. In addition to these measures, regulators are currently looking into breaking up the oligopoly that is the Big Four, perhaps in the hope that it will bring more clarity and competition to the accounting world. But don’t hold your breath.
In conclusion, I am not one to rely on figures from auditors — they’re human and prone to mistakes and lying like the rest of us. But I do believe that having an objective observer examine books and report the results to the public is a step up from what the cryptocurrency space currently finds acceptable. I would love verifiable evidence that Bitfinex didn’t hack itself, that Tethers have always been 1–1 backed, and that Coinbase didn’t frontrun customers… it’s just that no one else seems to care.
I can assure you, though, regulators do care.