If you are in the cryptocurrency space, many of you are either launching a new fund or preparing for the calendar year-end audit cycle now in full swing. We know you’re busy, yet we need to interrupt you for just a moment and draw your attention to one specific issue of immediate urgency to help ensure your crypto fund can be audited effectively: Making sure your investments and transactions are properly documented so they can be independently verified.
 
Why is this important? Let’s take a step back first. The fundamental purpose of a financial statement audit is to provide investors with independent verification that the financial statements report fairly the value and financial results of their investment. Auditing financial statements is a systematic process of objectively obtaining and evaluating evidence regarding that value and those results. Cryptocurrency funds have a variety of unique audit considerations due to the new and emerging technology surrounding digital assets. However, the objectives of a crypto fund audit are the same as any investment fund. To issue an unqualified opinion, the auditor must determine whether the financial statements are free from material misstatement, which considers: 

• Are all investments and transactions properly accounted for? This focuses on completeness, existence and right of ownership.
• Are all investments and transactions properly valued and disclosed using the appropriate fair value hierarchy? 

A major difference for crypto fund audits is in the procedures that must be performed to make these assessments. Independent confirmation of ownership of balances on a crypto exchange, in private wallets or an initial coin offering (ICO) will differ dramatically from the traditional confirmation with a securities broker or bank account. Reputable fund administrators and auditors should have a well-established plan for providing assurance as to the existence and valuation. Coin-tracking services and the nature of the public blockchain, along with other procedures, will often allow auditors to address the ownership concern for many of the coins held. Different independent verifications of ownership are applied to ICOs or hard-to-value cryptos.
 
Here is where we see the greatest challenge with a crypto fund manager’s ability to respond to the auditor’s information requests — providing a complete transactional history. Why is this critical? Auditors must have assurance that all inflows and outflows are properly accounted for — that is, that monies subscribed to the fund are recorded as increases to equity; that monies leaving the fund are for equity redemptions or payment of appropriate fund expenses and fees; that your realized gains and losses are in fact gains and losses and that all of them are recorded. So, if a fund is not able to provide a full picture of the transactions from which the auditor can select a sample to independently test and verify, then, Houston, we have a problem.
 
All fund managers must have adequate back- and middle-office processes so that the administrator, the auditor and the tax preparer can extract and aggregate transactional data for financial and tax purposes. No small task when your data isn’t homogeneous.
 
So now what? Some of you might remember the famous words by Vanilla Ice: Stop, collaborate and listen. 

Step 1: Stop

Take a moment to consider the following: 

• What is the process for documenting a transaction if the history is no longer available via the exchange’s records, especially since a screenshot provided by the fund manager is not considered independent?
• What transactional information do you, the administrator or others have access to? How much history is available?
• Did the administrator confirm start-of-year balances?
• Is the administrator regularly, i.e., weekly, collecting trade data from exchanges directly? Or are they relying on information from the investment manager?
• How can I provide independent confirmation of transaction history that is subjected to audit throughout the year? 

Step 2: Collaborate and Listen

One thing is for sure, you shouldn’t do this alone. You should seek the support of a trusted advisor to help you work through this and other issues as they arise. The answer isn’t going to be the same for every situation.
 
Without a great system in place, the process will likely be clunky and manual, which will cost you more time and potentially create a greater likelihood of errors. Or your auditor may require a continuous audit approach where transaction activity is tested at more frequent intervals throughout the year while the transaction information is available. Your process and controls will need to be developed in concert with your fund administrator’s process and with guidance from your auditor to develop a reasonable audit approach.
 
As institutional investors are looking to move into the crypto space, they will anticipate enterprise-grade reporting, infrastructure and policies. Developing a reasonable audit approach along with documented procedures for valuation and other operational considerations are just the beginning of institutionalizing your operations as you plan for future growth.
 
Please contact Jamie Gasiorowski at jamie.gasiorowski@cohencpa.com or a member of your service team for further discussion.
 
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.