The year 2022 was rough for the cryptocurrency sector as it witnessed several prominent collapses, scandals, and bankruptcies. Among the most notable events was the stunning fall of Terra stablecoin and token LUNA, which cascaded into a $300 billion wipe out from the total cryptocurrency market cap. The incident brought increased scrutiny to stablecoin issuers and questions were raised they had enough liquidity to repay their customers in the event of a crisis.

While the TerraLuna debacle resulted in large losses for investors, the failure of FTX and its subsequent influence on other crypto businesses provided another jolt to the market. These incidents were reported to have been caused due to mismanagement of funds and business misconduct, two threats that still plague the cryptocurrency sector.

Calls for external auditors are among the most significant measures being explored to bring more clarity on cryptocurrencies. In theory, an external auditor's function requires it to validate the books of a crypto-related business, which might dispel several concerns about how certain cryptocurrency-related firms run their businesses. However, this appears to be a distant prospect at the moment. According to a recent poll, half of the top crypto companies do not have an external auditor, making transparency an ongoing worry for the industry.

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Lack of External Auditor

In a recent survey conducted by Bloomberg, it was revealed that only 31 out of the top 60 crypto firms have undergone proper financial audits or received reserve attestations from an independent auditor. Numerous cryptocurrency-related companies blamed a lack of external auditing on the hesitation of big audit firms to work with them. The exact reasons as to why auditing firms might be reluctant to work with crypto businesses are unknown. However, the lack of experience required to audit blockchain firms, as well as the regulatory wormhole that continues to grow as a result of events such as the TerraLuna crash and the FTX downfall, might be dissuading audit firms from dipping their feet in the digital asset’s sector.

As a side note - independent or external auditors are certified public accountants who perform audits for companies with which they have no affiliation. Independent auditing provides credibility to the company and ensures the integrity of the audit process. It allows the public to trust in the accuracy of the results and protects investors or shareholders from fraudulent financial claims made by companies.

Is an independent board of directors important?

In traditional companies, as a startup grows, it is common practice to include at least one independent director on the board, in addition to the founders. However, in Bloomberg’s survey showed that that 38 of the top crypto firms have boards with at least one non-executive member, while 10 companies do not, and the remaining 12 firms either did not respond or did not have the information available in public filings.

The survey tracked various crypto entities such as exchanges like Coinbase and Binance, stablecoin issuers like Tether, mining businesses, and analytics firms like Chainalysis. Out of the 60 firms included in the survey, 17 declined to participate, and 8 did not respond.

An independent board of directors is important for a variety of reasons. For starters, they strike a balance between the firm and its shareholders by ensuring that the company's goals are realised while simultaneously offering the highest potential returns to their investors. Secondly, it also ensures that the company is not solely acting on the behest of a few individuals. Instead, the power of decision making is spread across several members and the majority need to be on the same page for a decision to be finalized.

As per the survey, stablecoin issuer Tether, crypto exchange Huobi, and NFT marketplace Magic Eden, lacked an independent board. Meanwhile, ccompanies like Kraken, Crypto.com, OpenSea, and Uniswap Labs confirmed having a board but declined to disclose information about its members.

The 60 companies included in the survey were selected based on criteria such as being publicly listed, having a valuation of over $1 billion in private fundraising, or holding significant influence in the sector, as of January 2023.

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Conclusion

Ruth Foxe Blader, a partner at crypto venture capital firm Anthemic, emphasized the importance of audits and independent boards in every company, especially those operating in the financial sector.

However, the crypto industry, which is supposed to be built on transparency and immutable record-keeping, appears to have fallen short in meeting its promises. John Salmon, head of law firm Hogan Lovells' digital assets and blockchain practice, believes that while independent auditing is a positive step, companies will fully embrace it only when regulations mandate such practices. The survey's findings, highlighting the lack of external auditors in half of the top 60 firms, indicate that most companies are currently following their own rules and will likely adopt such basic practices only under regulatory pressure.