Recently, the Chamber of Digital Commerce published The Practitioner’s Guide to an Emerging Standard for Increasing Trust and Transparency in Digital Asset Platform Services. The guide offers best practices on how entities serving as digital asset exchanges or custodians (“digital asset platforms”) can validate they are holding digital assets sufficient to cover their outstanding liabilities. This is referred to as a Proof of Platform Reserves (PoPR).
Presently, some digital asset platforms are providing varying forms of proof, but there is no consistent standard. The guide aims to create a standardized approach that every digital asset platform should become familiar with to help establish trust and transparency.
Why Does the Digital Asset Industry Need Guidelines in the Area of Proof of Platform Reserves?
Customers and prospective customers within the digital asset marketplace have been crying out for some type of public disclosure from the digital asset platforms to help properly assess risk and make an informed decision on which platforms to use.
PoPR can vary in complexity from a simple bitcoin only exchange to multi-asset exchange offerings. By delivering proof of sufficient assets, digital asset platforms improve trust with customers and establish some authority in their ability to self-regulate. Platforms typically hold customer assets in co-mingled wallets that are not publicly auditable. These assets are tracked by the digital asset platforms in ledger software separate from the blockchain. In addition, digital assets are bearer-like instruments, so the risks of misappropriation are different than traditional financial markets. There is also limited insurance available for digital asset deposit balances, and the platforms are more global in nature with varying degrees of regulation. The guidelines established by the Chamber’s guide provide a clear path to answering the need for an assurance framework associated with digital asset platforms.
What is an Independent Auditor’s Role in a Digital Asset Platform?
An independent practitioner adds value to a digital asset platform’s PoPR strategy, in particular an independent CPA auditor, as they can perform procedures to add credibility to both the liabilities and the collateral assets reported as part of the PoPR. An independent CPA auditor can perform an assessment and report in accordance with professional standards, which provides a high level of assurance for customers. The Chamber’s guide identifies the reporting framework as well as some of the procedures that may be used to identify and assess risks associated with the engagement, and the substantiation of the reported assets and liabilities. The guide also discusses the role evaluating financial reporting controls, including IT controls, will play within the auditor’s planned procedures.
The PoPR standard represents a combination of the finance industry’s traditional and digital asset sectors; however, the users of and investors in digital assets do not have all of the same regulatory clarity and standards of reporting as the traditional banking and financial markets. The guide highlights risks and considerations associated with the unique wallet and database infrastructure of a digital asset platform, the preferred balance between privacy and transparency, and other unique considerations for this non-traditional environment. For example, one such consideration is the difficulty for an auditor to verify that private keys are only owned and controlled by the digital asset platform. Additionally, the PoPR does not provide assurance regarding the solvency of a business entity, and, thus, there is potential for unaccounted-for liabilities — highlighting the need for continual evolution of the standard.
As the market capitalization for digital assets continues to expand and invite new entrants to the marketplace, it is incumbent on digital asset platforms to continue to mature. Now is the time to evaluate the PoPR standards within this guide and how it can help you build your customers’ confidence.
>> Read The Practitioner’s Guide to an Emerging Standard for Increasing Trust and Transparency in Digital Asset Platform Services
Contact Christian Hinder at Christian.Hinder@cohencpa.com or a member of your service team to discuss this topic further.
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.