Bassel Saleh & Co.


First In­dus­trial Rev­o­lu­tion cul­ti­vated mech­a­niza­tion and changed the way we pro­duce goods. The Sec­ond Rev­o­lu­tion used elec­tric power to cre­ate mass pro­duc­tion. The third rev­o­lu­tion lever­aged elec­tron­ics and in­for­ma­tion tech­nol­ogy to au­to­mate pro­duc­tion. Build­ing on the Third, the Fourth In­dus­trial Rev­o­lu­tion (4IR) brings the cy­ber-phys­i­cal sys­tems and dig­i­ti­za­tion of every­thing (Seow, 2018). Blockchain is one area that is ex­ten­sively be­ing ex­plored for the dig­i­ti­za­tion of every­thing. Satoshi Nakamoto de­vel­oped the rev­o­lu­tion­ary idea of the Bit­coin in 2008 which is based on blockchain tech­nol­ogy (BCT). The core idea of BCT is the de­cen­tral­iza­tion of the data­base among net­work users and the con­sen­sus of the nodes on the net­work to ap­prove adding any new block. Sup­port­ers of the BCT list in­her­ent lim­i­ta­tion in the cur­rent cen­tral­ized fi­nan­cial sys­tem in­clud­ing the pos­si­bil­ity of hack­ing per­sonal data stored with fi­nan­cial in­sti­tu­tions, bil­lions of un­banked pop­u­la­tions are ex­cluded from the global econ­omy and re­mit­tance fees to trans­fer cross-coun­tries reach to 10-20% (Seow, 2018). This ar­ti­cle dis­cusses the con­cepts of the blockchain tech­nol­ogy and the crypto-as­sets in­clud­ing the crypto-cur­ren­cies and Crypto- se­cu­ri­ties. More specif­i­cally, the ar­ti­cle dis­cusses the blockchain tech­nol­ogy, the crypto-cur­ren­cies, the se­cu­rity to­ken of­fer­ing and ini­tial coin of­fer­ing as con­tro­ver­sial means of fi­nance, the reg­u­la­tory en­vi­ron­ments sur­round­ing the blockchain fi­nan­cial prod­ucts, the In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dards “IFRS” point of view on ac­count­ing and re­port­ing of var­i­ous top­ics in the crypto-as­sets and fi­nally the ex­ter­nal au­di­tor chal­lenges in au­dit­ing such type of as­sets.

What is the Blockchain and the Dis­trib­uted Ledger Tech­nolo­gies?

Blockchain is sim­ply a chain of blocks, each block con­tains three things, the data, the hash of the cur­rent block, and the hash of the pre­vi­ous block. The data in the block de­pends on the type of the blockchain. For in­stance, a Bit­coin block con­tains the sender and the re­ceiver en­crypted iden­ti­fiers. The hash on the other hand is a value gen­er­ated from a string of text us­ing a math­e­mat­i­cal func­tion. Chang­ing some­thing in­side the block changes the hash. Adding a new block to the chain re­quires con­sen­sus of the par­tic­i­pat­ing nodes (users) which is achieved ei­ther by the proof-of-work or the proof-of-stake (dis­cussed later in this sec­tion) (Tania, 2018).

Dis­trib­uted ledger tech­nol­ogy (DLT) is a data­base that is dis­trib­uted among all par­tic­i­pat­ing nodes on the net­work where each node has an iden­ti­cal copy of the ledger. The un­der­ly­ing as­sump­tion is that all nodes on the net­work are not im­plic­itly trusted and they need a mech­a­nism by which all users on the net­work can reach a con­sen­sus on the sta­tus of the ledger (GSMA, 2018). Each par­tic­i­pat­ing node has a copy of all the blocks. That is why it is called a dis­trib­uted ledger ver­sus the cen­tral­ized ledger. For ex­am­ple, the cen­tral­ized ledger main­tained by a bank main­tains all data re­lated to cus­tomers and their bank­ing trans­ac­tions (Tania, 2018).

The con­sen­sus is achieved by ei­ther the proof-of-work or the proof-of-stake. Proof-of work mech­a­nism means that “the nodes all try to solve the math­e­mat­i­cal prob­lem, but it is the first node to solve the prob­lem that gets com­pen­sated, (and other users use the so­lu­tion pro­vided by the first node to ver­ify the prob­lem has been cor­rectly solved), while in the proof-of-stake, the user with the largest stake is nom­i­nated to con­firm the trans­ac­tion” (GSMA, 2018: p. 5). Those nodes that try to solve the math­e­mat­i­cal prob­lem are called the mi­nors who are those with proper com­put­ing power and try to solve a cryp­to­graphic puz­zle to cre­ate a new block on the blockchain (Grant Thorn­ton, 2018). This mech­a­nism is dif­fi­cult to fraud be­cause one with the in­tent to per­pe­trate fraud through, adding a new block, ad­just­ing ex­ist­ing block, or chang­ing the data in the blocks will have to hack the com­puter of every blockchain par­tic­i­pant and slip in the in­valid block. How­ever, even if this is pos­si­ble, none of the nudes would ver­ify the block. (Tania, 2018).

The con­sen­sus process is also af­fected by the type of net­work. Ac­cord­ing to Elas­rag (2019), BCT has three types: The pub­lic type, the pri­vate type, and the hy­brid. The pub­lic type is when the net­work is open to all users and any­body on the net­work can down­load the code and par­tic­i­pate in the con­sen­sus process and every­body on the net­work can see and au­dit a trans­ac­tion on the pub­lic block. No cen­tral en­ti­ties are in­volved and the iden­tity of the users is anony­mous (This is the type used in the Bit­coin cur­rency). The pri­vate type (called per­mis­sioned) is when a cen­tral or­ga­ni­za­tion con­trols the con­sen­sus process and the num­ber of nodes par­tic­i­pat­ing in the net­work. The last type is the Hy­brid (Fed­er­ated), It op­er­ates un­der the con­trol of a spe­cific group of or­ga­ni­za­tions that are al­lowed to per­form the role of full nodes. As op­posed to the pub­lic blockchain, the struc­ture does not give ac­cess to all per­sons to par­tic­i­pate in the process of ver­i­fy­ing trans­ac­tions. The con­sen­sus process is con­trolled by a pre­s­e­lected set of nodes in which the pro­to­col de­fines the min­i­mum num­ber re­quired to sign every block in or­der for the block to be valid.

The use of blockchain tech­nol­ogy (BCT) has evolved since Nakamoto in terms of use-cases in­clud­ing the use of BCT in cre­at­ing fi­nan­cial se­cu­ri­ties such as the Se­cu­rity To­ken Of­fer­ing (STO) and the Ini­tial Coin Of­fer­ing (ICO), the uti­liza­tion of the blockchain tech­nol­ogy to build busi­ness mod­els com­pet­ing with well-known on­line e-com­merce busi­ness such as Ar­cadeCity (ver­sus Ober) and Open­Bazaar (ver­sus Ama­zon), the role of the BCT in the de­vel­op­ment of the Web 3.0, in­sur­ance claim pro­cess­ing, In­ter­net-of-Things (IoT), Blockchain gov­ern­ments  (see Rosic (2018) and Hile­man and Rauchs, (2017) for other use-cases).

What are the Crypto-Cur­ren­cies?

Crypto-cur­ren­cies in­clude many dig­i­tal cur­ren­cies in­clud­ing among oth­ers, Bit­coin, Rip­ple (XRP), Lite­coin, and Ether. The com­mon fea­ture of these cur­ren­cies is that they are based on the blockchain tech­nol­ogy. Nev­er­the­less, they have dif­fer­ences. For in­stance, Ether is based on a de­cen­tral­ized plat­form that runs smart con­tracts which are pro­to­cols that en­force or ne­go­ti­ate con­tracts through code, while Bit­coin de­sign is lim­ited to spe­cific logic (peer-to-peer elec­tronic cash sys­tem) (Ernst and Young, 2018). This sec­tion an­swers the ques­tion about the char­ac­ter­is­tics of the crypto-cur­ren­cies by dis­cussing the fiat money and con­trast­ing it to the crypto-cur­rency. Fiat money is the cur­rency units that we deal with every day such as U.S. dol­lars, the Japan­ese Yen, or the United Arab Emi­rates dirham. These cur­ren­cies have phys­i­cal sub­stance, de­posited in banks, and trans­ferred be­tween bank­ing ac­counts. The sup­ply of these cur­ren­cies is con­trolled by cen­tral banks (the Fed in the case of the U.S. dol­lars). The trans­fer of funds is mon­i­tored and the iden­ti­ties of the trans­fer­rer and the ben­e­fi­ciary are main­tained within the bank­ing sys­tem. The cen­tral bank in each coun­try runs the mon­e­tary pol­icy wherein the sup­ply of funds into the mon­e­tary sys­tem is con­trolled in or­der to con­trol the macro­eco­nomic vari­ables such as in­fla­tion. The fiat cur­ren­cies are guar­an­teed by the is­su­ing gov­ern­ments. On the other hand, crypto-cur­rency is gen­er­ally de­fined by (Nashirah et al., 2017: p. 20) as “a dig­i­tal cur­rency in which en­cryp­tion tech­niques are used to reg­u­late the gen­er­a­tion of units of cur­rency and ver­ify the trans­fer of funds, op­er­at­ing in­de­pen­dently of a cen­tral bank ……work as a medium of ex­change us­ing cryp­tog­ra­phy to se­cure the trans­ac­tions and to con­trol the cre­ation of ad­di­tional units of the cur­rency”. Crypto-cur­ren­cies dif­fer from fiat money in that: First, the iden­tity of the users is anony­mous (in the case of pub­lic blockchain sup­port­ing Bit­coin for in­stance). Sec­ond, dig­i­tal money is not sup­ported by cen­tral banks, rather it is sup­ported by the con­sen­sus of all the users on the net­work who are par­tic­i­pat­ing in the crypto-cur­rency trans­ac­tions and by the strength of the chain link be­tween the blocks of the trans­ac­tions that are pro­tected by the cryp­to­graphic tech­nol­ogy. Third, the ledger of all trans­ac­tions in the crypto-cur­ren­cies is dis­trib­uted among the par­tic­i­pat­ing net­work nodes.

Crypto-cur­ren­cies are traded on crypto-cur­rency ex­changes. There are 314 ex­changes world­wide. The biggest three ex­changes in terms of mar­ket cap­i­tal­iza­tion are Bi­nance, Huobi Global and Coin­base Pro.

What are the STO and ICO?

STO stands for Se­cu­rity To­ken Of­fer­ing while ICO stands for Ini­tial Coin Of­fer­ing. These two de­f­i­n­i­tions are used in­ter­change­ably since there is no uni­ver­sal gen­er­ally-ac­cepted de­f­i­n­i­tion of what con­sti­tutes an STO and an ICO.

Crypto-as­sets are di­vided into three ar­che­types, the pay­ment or ex­change to­ken, the se­cu­rity to­ken, and the util­ity to­ken. All of the to­kens share the same fea­ture of be­ing crypto-as­sets based on the BCT. The pay­ment to­ken is sim­i­lar to the crypto-cur­rency dis­cussed ear­lier and used for pay­ment, while the se­cu­rity to­ken is a sort-of in­vest­ment to­ken that pro­vides the holder, among oth­ers, with a share of the un­der­ly­ing as­set, right to div­i­dends or right to vote. Util­ity to­ken on the other hand pro­vides the holder with ac­cess to func­tions pro­vided di­rectly by the to­ken is­suer (De­loitte, 2019., Ante and Fiedler, 2019 and PwC, 2019).

STO and ICO have sim­i­lar­i­ties and dif­fer­ences from the IPO. On one hand, the IPO (ini­tial pub­lic of­fer­ing) is the way by which or­ga­ni­za­tions of­fer debt or eq­uity se­cu­ri­ties to the pub­lic un­der the rules of the lo­cal or for­eign se­cu­rity ex­change mar­kets. This type of of­fer­ing is served by in­ter­me­di­aries such as the in­vest­ment bankers and bro­kers and is ap­proved by the ex­change au­thor­i­ties be­fore pub­li­ca­tion. The price is de­ter­mined based on the fun­da­men­tals of the is­suers and the un­der­ly­ing as­set. Some is­sues might not be el­i­gi­ble for all in­vestors, only those with min­i­mum wealth are al­lowed in or­der to pro­tect light cap­i­tal in­vestors. The prospec­tus is the doc­u­ment that is used by the is­suers to con­vey to the pub­lic the de­tails of the of­fer and what type of own­er­ship as well as the price and re­turn and risks in­volved. Once sold to the pub­lic, the se­cu­ri­ties (stocks or bonds for in­stance) are then pub­licly traded on the ex­change mar­kets and the records of those trans­ac­tions in­clud­ing the price, the vol­ume, and seller and buyer are stored and con­trolled by the mar­kets. On the other hand, the STO and ICO of­fer­ing is dig­i­tal­ized and the tech­nol­ogy used to fa­cil­i­tate the of­fer­ing is the BCT. In gen­eral, the is­suer pre­pares a busi­ness-case pub­lished through a white-pa­per (sim­i­lar to the prospec­tus) which iden­ti­fies the use case, the cap­i­tal needed, and de­fines the sell­ing price (BDO, 2019). The amounts are set­tled in crypto-cur­rency or fiat money. The se­cu­rity given to the in­vestors is dig­i­tal and is used by the in­vestor to ei­ther uti­lize the ser­vices of­fered by the busi­ness (ICO) or to ev­i­dence a share of own­er­ship in the un­der­ly­ing busi­ness or as­set (STO).

STO and ICOs are traded on blockchain ex­changes. For in­stance, Global Blockchain Ex­change (GBX) is a com­pany reg­is­tered un­der Gibral­tar laws that list to­ken is­sued by com­pa­nies spe­cial­ized in the blockchain-based se­cu­rity to­ken in­vest­ments.

ICO of­fer­ing pro­vides an op­por­tu­nity for busi­nesses of small and medium-size to ob­tain fi­nanc­ing that is not avail­able to them through tra­di­tional IPO. This is due to the fact that ICO does not un­dergo the same reg­u­la­tory pro­ce­dures and does not have the same rules im­posed by se­cu­rity ex­change mar­kets dur­ing the IPO process (OECD, 2019). ICO is­suers have le­gal and reg­u­la­tory risk due to un­clear reg­u­la­tions, risk of fraud, risk of hack­ing (re­fer to the DAO case in the reg­u­la­tory per­spec­tive sec­tion), the volatil­ity of to­ken prices due to spec­u­la­tion, in­ad­e­quate Ant—Money laun­der­ing and know your cus­tomer pro­ce­dures, data pri­vacy is­sues and op­er­a­tional risk re­lated for in­stance to solv­ing cod­ing er­rors (OECD, 2019). The ICO is not suit­able for all busi­nesses be­cause these blockchain-based to­kens do not grant any right of own­er­ship or div­i­dends. On the other hand, STO is blockchain to­kens that grant these rights to the in­vestor (Ante and Fiedler, 2019).

Al­though ICO/STO are ef­fi­cient tools to raise fi­nance for en­ter­prises that would oth­er­wise find it dif­fi­cult to raise such fund­ing, the in­vest­ment in these se­cu­ri­ties is not risk-free. En­ti­ties as well as in­di­vid­u­als would need to un­der­stand the pros and cons of the in­vest­ment in or­der to avoid tak­ing an un­cal­cu­lated risk.

What is the reg­u­la­tory stance for crypto-as­sets?

There are cer­tain coun­tries that ban the ICO/STO se­cu­ri­ties such as China, In­dia, and Pak­istan. Other coun­tries have ex­ist­ing reg­u­la­tions or still in the process of de­vel­op­ment of new ones in­clud­ing among oth­ers, the USA, Thai­land, Bahrain, and Lux­em­burg. On the other hand, there are cer­tain coun­tries that have fa­vorite reg­u­la­tory en­vi­ron­ments such as Uzbek­istan, Tai­wan, Japan, Lithua­nia, Es­to­nia, Slo­va­kia, and Switzer­land. In Switzer­land for ex­am­ple, the Fi­nan­cial Mar­ket Su­per­vi­sory Au­thor­ity is­sued guide­lines con­cern­ing the reg­u­la­tion of the ICO is­suance as a util­ity, as­set, and pay­ment to­kens. The au­thor­ity as­sesses the is­sues case-by-case against the se­cu­ri­ties law for any breach.

As an­other ex­am­ple, in the U.S.A, the de­f­i­n­i­tion of the se­cu­ri­ties is very wide, how­ever, the U.S. reg­u­la­tor ap­plied the U.S. se­cu­ri­ties law, in a re­port, on the DAO case, which is a case of a Ger­man ori­gin de­cen­tral­ized en­tity which sold to­kens to in­di­vid­u­als in ex­change for Ether and then due to hack­ing of the Ether by an out­sider, a hard fork was nec­es­sary  (re­fer to IFRS sec­tion for more dis­cus­sion about hard fork). This re­port clar­i­fies the im­por­tance placed on com­pli­ance with se­cu­ri­ties laws for those in­ter­ested in the of­fer­ing of se­cu­ri­ties to the pub­lic, it is clear that ac­cord­ing to the reg­u­la­tor in the U.S, any is­suer of se­cu­ri­ties in the U.S. whether elec­tronic or not should reg­is­ter with the com­mis­sion and com­ply with the se­cu­rity law or file for ex­emp­tion there­from.

The con­tra­dic­tions among coun­tries with re­gards to the le­gal sta­tus of the crypto-as­sets that raises a red flag re­gard­ing the com­plex­ity in­her­ent in the in­vest­ment in crypto-fi­nan­cial se­cu­ri­ties. There­fore, the de­ci­sion on in­vest­ing in the STO and the ICO should not be taken lightly by in­vestors be­fore en­sur­ing that all their rights are prop­erly pro­tected by laws of the rel­e­vant ju­ris­dic­tion.

What are the IFRS re­quire­ments for ac­count­ing on crypto-as­sets?

The IFRIC met in Lon­don in June 2019 (IFRIC, 2019) and con­cluded on how to ac­count and dis­close the hold­ing of crypto-cur­ren­cies. The de­ci­sion was that the hold­ing of crypto-cur­ren­cies is ac­counted for as in­tan­gi­ble as­sets un­der IAS 38 un­less the cur­rency is held for re­sale, then it is ac­counted for un­der IAS 2 as in­ven­tory at the lower of cost or net re­al­iz­able value. In ad­di­tion, the IFRIC de­ci­sion im­posed cer­tain dis­clo­sure about the crypto-cur­ren­cies in­clud­ing the dis­clo­sures needed as per the rel­e­vant stan­dard IAS 38 and IAS2 based on the case, the IFRS13 fair value dis­clo­sures, the judg­ment used by man­age­ment, and sub­se­quent even dis­clo­sure if those events are sig­nif­i­cant to the users of the fi­nan­cial state­ments. The de­ci­sion of the IFRIC is only dis­cussing the treat­ment for the hold­ing of the crypto-cur­ren­cies. How­ever, it does not dis­cuss the hold­ing of crypto-cur­ren­cies on be­half of oth­ers, the is­su­ing and hold­ing of the crypto-as­sets nor dis­cusses the min­ing rev­enues. These three ar­eas are dis­cussed be­low as fol­lows:

First, re­gard­ing the hold­ing of Crypto-cur­ren­cies on oth­ers’ be­half, Ernst and Young (2018) dis­cusses that the Ac­count­ing Stan­dards Board of Japan is­sued an ex­po­sure draft in De­cem­ber 2017 for pub­lic com­ment (Prac­ti­cal So­lu­tion on the Ac­count­ing for Vir­tual Cur­ren­cies un­der the Pay­ment Ser­vices Act). The dealer who holds the vir­tual cur­rency on be­half of a cus­tomer, in the case of hav­ing a con­tract with the cus­tomer to hold the cur­ren­cies, will rec­og­nize ini­tially an as­set and a cor­re­spond­ing li­a­bil­ity at the fair value of the cur­rency at the date of de­posit. Sub­se­quently, the as­set and li­a­bil­ity are mea­sured sim­i­larly to the first case dis­cussed in the draft. There­fore, the net re­sult is no gain or loss is re­ported in the profit or loss ac­count. By the same to­ken, PwC (2019) ar­gues that if the en­tity hold­ing the crypto-as­set on be­half of oth­ers have the right to bor­row the as­set and use it for its own ben­e­fit, then the crypto-as­set can be re­garded as an as­set, and if the cus­tomer for which the as­set is be­ing held has the right to re­cover the as­set (the un­se­cured cred­i­tor), then an as­set and a li­a­bil­ity are to be rec­og­nized.  There­fore, the treat­ment is de­pen­dent on the cir­cum­stances.

Sec­ond, re­gard­ing the is­suance of the dig­i­tal se­cu­ri­ties, Ernst and Young (2018) clar­i­fies that a pre-sale of the ICO to­ken is con­sid­ered as a for­ward con­tract un­der the US se­cu­ri­ties law wherein one party agree to buy a to­ken from an­other party in the fu­ture and that fi­nan­cial re­port­ing should fol­low this lead. PwC (2019) dis­cusses the ac­count­ing treat­ment of the holder and is­suer of the crypto-as­sets. More specif­i­cally, the ac­count­ing treat­ment of the holder and is­suer of the STOs and ICOs. The main idea is that one should in­spect the facts and cir­cum­stances re­lated to the is­sue to iden­tify the proper treat­ment. First, as far as the is­suer is con­cerned, if the to­ken pro­vides the con­trac­tual right to the holder to re­cover the money in­vested at some point in time, such to­ken would be ac­counted for un­der IFRS 9. If the to­ken pro­vides for a share in resid­ual in­ter­est in the is­su­ing en­tity, then the to­ken is an eq­uity in­stru­ment un­der IAS 32. PwC (2019) ar­gues that these two cases are not likely.  On the other hand, if the to­ken is­sued is in ex­change for fu­ture ser­vices at a dis­counted price as is the case of the util­ity to­ken, IFRS 15 can be ap­plied as if the amount re­ceived was a pre­pay­ment from a cus­tomer for un­earned rev­enue. Sec­ond, with re­gards to the holder of the to­ken, if the to­ken pro­vides right to the un­der­ly­ing as­set wherein the holder can trade the as­set at a min­i­mal cost with­out phys­i­cally hold­ing it (as­set-backed to­ken), the rel­e­vant stan­dard re­lated to the ac­count­ing of the un­der­ly­ing as­set can be used. If the to­ken pro­vides the right to the holder to uti­lize fu­ture ser­vices when avail­able at dis­counted prices, the to­ken can be treated as a pre­pay­ment un­less it meets the de­f­i­n­i­tion of an in­tan­gi­ble as­set and If the to­ken pro­vides the right to the net as­set of the is­suer, a fi­nan­cial as­set is con­sid­ered un­der IFRS 9.

Third, re­gard­ing the min­ing ac­tiv­i­ties ac­count­ing, Grant Thorn­ton (2018) analy­ses the ac­count­ing treat­ment of the trans­ac­tion fees that the mi­nors and val­ida­tors earn while solv­ing the com­pu­ta­tional prob­lem (see Blockchain and Dis­trib­uted ledger tech­nolo­gies para­graph). The study sug­gests three things for mi­nors. First, mi­nors who are el­i­gi­ble for a share of the new block to record a rev­enue equal to the trans­ac­tion fee based on the fact that there ex­ists a cus­tomer con­tract with clear per­for­mance oblig­a­tion and price as per IFRS 15. Sec­ond, mi­nors with block re­ward i.e. are re­warded a new block, not a share of, to rec­og­nize other in­come be­cause a con­tract with the whole com­mu­nity of mi­nors does not ex­ist. There­fore, rev­enue can­not be rec­og­nized as per IFRS 15. Third, for a pool of mi­nors, the con­tract is ei­ther among the mi­nors as a joint arrange­ment or be­tween the mi­nors and the pool op­er­a­tor. The trans­ac­tion price in the lat­ter is vari­able be­cause the share of com­put­ing power con­tributed by the mi­nor to the pool is not known un­til the block com­pu­ta­tional prob­lem is solved. There­fore, the vari­able fee de­ter­mi­na­tion steps in IFRS 15 are to be fol­lowed. More­over, the study dis­cusses the in­ter­nally gen­er­ated in­tan­gi­ble as­sets un­der IAS 38 and con­cludes that the gen­er­ated crypto-as­set is not rec­og­nized un­til sold and that the cost is to be ex­pensed as in­curred be­cause it can­not be mea­sured re­li­ably.

In ad­di­tion to the above, Ernst and Young (2018) dis­cusses the spe­cial case of hard and soft fork ( the hard fork is when the blockchain pro­to­col soft­ware is changed and a new crypto-cur­rency is added be­sides the orig­i­nal one, while the soft fork is when the pro­to­col soft­ware is only up­dated) and con­cluded that the hard fork re­sults in new as­set granted to the owner be­sides the pre­vi­ous as­set and that this new as­set should be ac­counted for with cor­re­spond­ing in­come state­ment ef­fect, but the study did not iden­tify what type of in­come. In the case of the short-sell­ing po­si­tion of crypto-cur­rency while the hard fork is tak­ing place. This is dis­cussed in the pa­per to re­sam­ple the case of an eq­uity short-seller who re­ceives div­i­dends and even­tu­ally owes these div­i­dends to the owner.

There is no IFRS that gov­erns the ac­count­ing and dis­clo­sure of all types of crypto-as­sets. As dis­cussed in this Sec­tion, IFRIC com­mit­tee de­ci­sion in 2019 con­cerned only the crypto-cur­ren­cies and did not cover the STO and ICOs for ex­am­ple. There­fore, in­ter­ested users and pre­par­ers of fi­nan­cial state­ments ac­cord­ing to IFRS would need to fol­low rel­e­vant IFRS guid­ance and make sure to be con­sis­tent in the logic used un­til the IASB fi­nally is­sues a re­lated IFRS stan­dard.

What are the sug­gested ex­ter­nal au­dit pro­ce­dures?

The topic of au­dit­ing blockchain-based trans­ac­tions and as­sets is an im­por­tant topic as it is new to the au­dit pro­fes­sion and re­quires that the au­di­tor to pos­sess the nec­es­sary un­der­stand­ing of the blockchain ecosys­tem and mech­a­nism to be able to ad­dress the dif­fer­ent risk of ma­te­r­ial state­ments with proper au­dit pro­ce­dures. Cana­dian Pub­lic Ac­coun­tancy Board (CPAB) in 2018 pub­lished an ar­ti­cle re­gard­ing au­dit­ing in the crypto-as­set sec­tor. The dis­cus­sion to fol­low is de­rived from that pa­per un­less oth­er­wise stated.

As far as the crypto-as­sets au­dit is con­cerned, the au­di­tors’ ar­eas of in­ter­est are the ex­is­tence, own­er­ship, and rights of the crypto-as­sets, the oc­cur­rence of crypto trans­ac­tions, rev­enue from min­ing ac­tiv­i­ties, im­pair­ment of min­ing as­sets, re­lated party trans­ac­tions, val­u­a­tion of crypto-as­sets and sub­se­quent events.

Existence of the crypto-assets and occurrence of the crypto transactions

Gen­er­ally, au­di­tors are re­quired to ob­tain an un­der­stand­ing of the un­der­ly­ing blockchain tech­nol­ogy sup­port­ing the crypto trans­ac­tions and should in­volve ex­perts to check the re­li­a­bil­ity of the pro­to­cols and cryp­tog­ra­phy as­so­ci­ated with the blockchain trans­ac­tions be­fore re­ly­ing on the blockchain ledgers. Fur­ther, the au­di­tor should iden­tify the con­trols rel­e­vant to the com­plete­ness, oc­cur­rence, and sub­se­quent mod­i­fi­ca­tion of trans­ac­tions on the blockchain ledger by look­ing into mit­i­gat­ing con­trols in­clud­ing val­i­da­tion al­go­rithms and con­sen­sus mech­a­nism, and test whether these con­trols are op­er­at­ing as in­tended. In ad­di­tion, au­di­tors are ex­pected to use block ex­plorer tools to re­view the in­for­ma­tion recorded on the block ledgers. As far as the rights to the crypto-as­set are con­cerned, a risk of fraud ex­ists in the sense that the en­tity claims a right to the as­set through the con­trol of the pri­vate key, while oth­ers also have the same pri­vate key and con­trol the same as­set. Sug­gested au­dit pro­ce­dures in this area in­clude: First re­quest­ing the en­tity to use its pri­vate key to trans­fer part of the as­set be­tween dif­fer­ent wal­lets con­trolled by the en­tity. Sec­ond, the au­di­tor will need to test the con­trols specif­i­cally de­signed to mit­i­gate the fraud risk by look­ing for in­stance whether the key gen­er­a­tion is done through a cryp­to­graph­i­cally con­trolled man­ner, whether the multi-sig­na­ture pro­to­col is per­formed be­fore a trans­ac­tion is ex­e­cuted and whether ef­fec­tive ITGC is de­signed over dig­i­tal wal­lets. Fi­nally, when a client keeps the pri­vate key cus­tody with the crypto ex­changes which might not have a ser­vice au­di­tor re­port on in­ter­nal con­trols at the ser­vice or­ga­ni­za­tion, the au­di­tor will need to test the con­trols at the ser­vice or­ga­ni­za­tion di­rectly.

Revenue from mining activities

In the case of the min­ing pool dis­cussed ear­lier un­der the IFRS per­spec­tive sec­tion, the au­di­tor will need to un­der­stand the pool­ing agree­ment and the fee al­lo­ca­tion mech­a­nism to the pool par­tic­i­pant. There­after, the au­di­tor should de­sign au­dit pro­ce­dures that ad­dress the risks as­so­ci­ated with rev­enue recog­ni­tion of the trans­ac­tion fees in­clud­ing risk re­lated to oc­cur­rence, com­plete­ness, and ac­cu­racy. Vouch­ing of cash re­ceipts is not enough.

Impairment of mining assets

In the price-de­clin­ing en­vi­ron­ment of the crypto-as­sets, min­ing com­pa­nies should be skep­ti­cal of the value of their min­ing as­sets. Au­di­tors should be skep­ti­cal too by ver­i­fy­ing if an im­pair­ment is re­quired.

Related party transactions

Pub­lic ad­dress in the blockchain con­sists of al­phanu­meric strings and can­not be as­so­ci­ated with spe­cific iden­ti­ties which makes it dif­fi­cult for au­di­tors to check re­lated party trans­ac­tions in the crypto as­sets. There­fore, au­di­tors should as­sess this area as a sig­nif­i­cant risk and de­sign pro­ce­dures to as­sess the busi­ness pur­pose of the trans­ac­tions and if these trans­ac­tions are held in the arm’s length.

Valuation of crypto-assets

The val­u­a­tion of crypto-as­sets is a sig­nif­i­cant risk for au­di­tors. If the as­set is traded in mul­ti­ple ac­tive mar­kets, the au­di­tor should iden­tify the prin­ci­ple mar­ket. If no ac­tive mar­ket ex­ists, the au­di­tor will re­quire the help of a val­u­a­tion spe­cial­ist.

Subsequent events

Due to sig­nif­i­cant risk in­her­ent in ex­is­tence and own­er­ship of the crypto-as­sets, the au­di­tor should per­form sub­se­quent event test to en­sure that the as­set still ex­ists and owned by the en­tity af­ter re­port­ing date and be­fore the au­dit re­port date.

Con­clud­ing re­marks

Blockchain tech­nol­ogy has brought a lot of chal­lenges to the au­dit and fi­nance pro­fes­sion­als as well as to reg­u­la­tors. These chal­lenges stem from the fast ad­vances in the tech­nol­ogy that do not have a cor­re­spond­ing re­ac­tion from fi­nan­cial and au­dit stan­dard set­ters as well as the reg­u­la­tors. At the same time, this tech­nol­ogy pro­vided an in­vest­ment op­por­tu­nity for re­tail in­vestors and ef­fi­cient and timely fund­ing op­por­tu­ni­ties for small and medium-sized en­ter­prises. In this con­tin­u­ally de­vel­op­ing en­vi­ron­ment, one would need to ob­tain proper ed­u­ca­tion with re­gards to the ba­sics of the blockchain and dis­trib­uted ledger and pre­pare for the vast ex­pan­sion of the use-cases of the tech­nol­ogy as dis­cussed ear­lier in this ar­ti­cle. This ar­ti­cle sheds light on the tech­nol­ogy ba­sics, the use-cases in­clud­ing the dig­i­tal cur­ren­cies, the STO, and ICO. In ad­di­tion, the ar­ti­cle dis­cussed the reg­u­la­tory en­vi­ron­ment sur­round­ing the STO and ICO and dis­cussed the re­cent an­nounce­ments in the IFRS and in the au­dit with re­gards to the crypto-as­sets. It is rec­om­mended that fur­ther re­search is con­ducted to ex­plore in more depth each area of the BCT in­clud­ing those top­ics dis­cussed in this ar­ti­cle in or­der to en­rich the lit­er­a­ture for those in­ter­ested in in­vest­ing and re­search­ing in the crypto-as­set do­main. More­over, it is im­por­tant to note that this ar­ti­cle is not in­tended to draw con­clu­sions on the suit­abil­ity of the STO or the ICO to any in­vestor as an in­vest­ment ve­hi­cle; such de­ci­sions should be taken in con­sul­ta­tion with ex­pe­ri­enced fi­nan­cial and le­gal ad­vi­sors.

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