Why would a Bitcoin audit be required?

The New York State Department of Financial Services have proposed Bitlicense regulations which would require licensees to submit audited annual financial statements. If these regulations are passed it is possible that authorities in other jurisdictions would implement similar requirements.

For example, we note that online gambling was initially illegal in many jurisdictions around the world, but one by one, governments have been licensing operators and subjecting them to heavy taxes.

However, even if Bitcoin audits do not become mandatory, it could become best practice for Bitcoin businesses to undergo an audit of their financial statements. Many Bitcoin exchanges have already had independent tests to prove their level of Bitcoin reserves so the next step could be to have their financial statements audited.

A Bitcoin audit could be also be required in the UK if a company exceeds the small company limits or is deemed to be an ineligible company.

What does an audit of financial services generally involve?

In the UK, a company has to produce a set of annual accounts in accordance with generally accepted accounting principles (eg UK GAAP or IFRS) and Companies Act 2006. However, if a financial director produces a set of accounts, how would a user or reader of the accounts know whether or not they can trust its contents?

An auditor will independently verify whether the accounts are true and fair and in compliance with the applicable laws and regulations. The auditor will need to be suitably qualified, be named on the Audit Register and will need to perform the audit in accordance with International Standards on Auditing.

An auditor will obtain a full understanding of the business and the industry in order to perform a risk analysis and to plan the audit. They’ll need to consider what the key balances and transactions are and which ones are most susceptible or fraud or error.

Once the audit has been planned they’ll work through the accounts to verify and corroborate the assets, liabilities income and expenses that have been included in the accounts and also to test for any significant transactions or balances which have been omitted.

Key risks for a Bitcoin audit

A Bitcoin business would have assets, liabilities and transactions denominated in Bitcoin. Key risks would include whether Bitcoin assets (eg reserves in cold storage) and liabilities (eg customer deposits) exist, are correctly valued and whether they are complete.

It may be possible to obtain sufficient, appropriate evidence about existence and completeness for exchanges by using an approach similar to that used by Stefan Thomas and his tools such as Easy Audit. Other Bitcoin businesses may need different techniques. Depending on the type of Bitcoin business and the complexity of its transactions, an auditor may require a cryptographer or IT specialist to perform such procedures in order to comply with ISA 620.

Bitcoins are likely to be treated as a cash equivalent/ foreign currency or as an investment, depending on how the business uses them and its intentions. In order to ensure they’re correctly valued, they would need to be translated into the base currency used in the financial statements (eg £ in the UK) and an adjustment may be required depending on the accounting policy.

A Bitcoin business is likely to be involved in online transactions and the transfer of funds, so internal controls and anti-money laundering procedures are also likely to be key areas for a Bitcoin audit.

We can help

Our team have audited both financial services businesses and e-commerce businesses and can use this experience to help us audit a Bitcoin business efficiently and effectively.

For example, a large online gaming businesses had millions of customer accounts and we had to verify the total liabilities owed to customers, as well as testing a sample of individual deposit/withdrawal transactions and interactions with payment gateways.

The financial services businesses we audit have complex accounting/tax rules such as mark to market/fair value and also strict rules for anti-money laundering and dealing with client money.

Please contact us for assistance and we’ll be happy to offer a free consultation where possible.