(Bloomberg) -- Before filing for bankruptcy last November, many of the companies in Sam Bankman-Fried's vast FTX empire had never held board meetings. The cryptocurrency exchange itself, which was once valued at $32 billion and raised $1.8 billion in venture capital, formed a board of three directors at the end of its life.
A subsidiary of trading firm Alameda Research, which reportedly has unlimited access to FTX clients' assets to fund their bets, was keeping books so bad that Bankman-Fried told staff their books were "unverifiable," si reads in a new management report. group. Occasionally, the company would find $50 million worth of assets "just lying around and we'd lose track of them," said Bankman-Fried. Now the former chief executive is accused of fraud, money laundering and bribing Chinese officials, while investors and clients have suffered billions of dollars in losses.
The lack of effective corporate governance and due diligence on FTX's books has led to worldwide disappointment. However, this is not an unfamiliar story to observers of the cryptocurrency industry.
© Bloomberg FTX founder Sam Bankman-Fried back in court after going viralIn the first quarter, Bloomberg News surveyed 60 major crypto companies, including all exchanges, miners, analyst firms and token issuers, to assess governance and oversight in the industry (1), including Binance, Coinbase Global Inc., Tether and OpenSea control flows of assets worth tens of billions of dollars every day. And while many adhere to traditional norms, many operate outside them.
Read more: Coinbase faces “existential risk” of SEC crackdown on cryptocurrenciesEach was asked the same set of questions to gauge how many of the major cryptocurrency companies employ external auditors and have independent boards of directors. More than half of the companies responded in full or in part, 17 refused to participate and eight did not respond at all. For some people who opt out, this information is publicly available.
"This is an anonymity industry masquerading as transparency."
According to the findings, about half of the companies surveyed currently hire an independent auditor to evaluate their finances. 63% of companies now have an independent board of directors, meaning they have at least one non-executive director. According to PitchBook or other public information, nearly all of the 60 companies surveyed had attracted outside investment early on.
"Independent audits and boards of directors are the core standards every investor expects from a company, especially companies of a certain size that are in the financial sector," said Ruth Fox Blader, venture capital partner at Digital Financial Services. Hymn company. But when it comes to cryptography - a sector whose technology promises openness and indelible records - the industry as a whole has failed to take that responsibility.
“This is an industry of anonymity disguised as transparency,” Ruth Fox Blader, a partner at digital financial services firm Anthemis, said in an interview.
© Source: Bloomberg News Finance under scrutiny | Half of the most influential companies in the cryptocurrency industry are currently receiving full financial audits or certification of their books by independent auditorsInvestor expectations change
Cryptocurrencies are a fledgling industry with only a handful of 60 companies registered and subject to certain regulatory standards. Disclosure requirements can vary around the world, and a lack of disclosure doesn't mean there's anything to hide. But the recent spate of cryptocurrency scandals and a general decline in venture capital investments have heightened the risks.
This makes some investors smarter and more cautious. Regulators are also concerned about a recent proposal from the New York Attorney General that would require cryptocurrency exchanges to seek independent government audits.
Read more: New York AG proposes breakthrough in cryptocurrency law, citing 'dysfunction'While a startup's board typically consists only of its founders during the initial investment, there should be at least one outside director during a Series A round, said David Pacman, managing partner at cryptocurrency firm CoinFund.
“This is what we expect now,” he said, noting that cryptocurrency investors were increasingly aligning their expectations with the standards required for traditional tech venture funding. He added that late-stage tech companies need board approval to spend above a certain level, another expectation "which also applies to cryptocurrencies."
revision pain
Audits have become a hot topic for the cryptocurrency industry in recent years. According to Rana Jared, general partner of Balderton Capital, while startups can be very popular with investors without having to generate enough revenue to justify a financial audit, investors typically expect an audit when a company's annual revenue exceeds $20 million. of dollars.
Many cryptocurrency firms have said that major accounting firms are reluctant to work with them, in part due to their lack of blockchain accounting experience and their history of fraud and scandals. Several firms, including cryptocurrency exchanges Binance and Bitfinex, indicated in their responses that the Big Four accounting firms were unwilling or unable to work with digital asset firms like theirs.
The survey results show that approximately 46% of the 24 companies that disclose information about their current auditors indicate that a comprehensive financial audit is conducted by Big Four auditors. Coinbase, Circle and Ripple all said they receive annual audits from Deloitte, while EY has appointed Chainalysis, Ledger and Anchorage Digital as auditors. Most companies have also been subjected to continuous external audits of their finances for at least three years.
© Source: Bloomberg News Audit Panorama | The big four accounting firms account for 46% of controlled crypto firmsSome accounting firms are now reluctant to partner with industry. France-based Mazars Group, which previously provided reports on assets held in reserve on exchanges Binance and Crypto.com, suspended all such work in December, citing "concerns about how these reports are perceived by the public." be.” According to a company spokesperson, both Binance and Crypto.com hired new reviewers, but declined to say which ones.
Read more: Accountant who audited Binance reserves abandons cryptocurrenciesEmpty meeting room
Without a comprehensive regulatory framework in other areas of finance, some cryptocurrency companies will have little incentive to catch up, according to investors and experts.
Companies registered in countries such as the US, UK and EU are required to have a board of directors as a condition of trading, but new companies often have a previous board of directors. , because venture capitalists usually require space as a condition. investment.
While 38 of the cryptocurrency companies surveyed have boards of directors with at least one non-executive director, the results show that 10 do not and 12 do not answer questions or have information not available in public records. Those without independent boards include Tether, Huobi and Magic Eden, whose boards are purely advisory or composed entirely of company executives.
By the end of this year, Binance will likely have a formal board overseeing the core group as it seeks to register with regulators around the world, exchange compliance chief Noah Perlman said in an interview.
© Source: Bloomberg News External Governance | Nearly two-fifths of the most influential cryptocurrency companies don't have independent boards of directors and don't disclose them when they do.However, not all cryptocurrency companies work with client funds, reducing incentives to strengthen corporate governance. Several companies say they have boards of directors but refuse to confirm membership, including Crypto.com, Kraken, Uniswap Labs and OpenSea.
Fox Blader and Jared argue that boards of directors can help prevent corporate crime because the tech and finance sectors self-regulate corporate failures.
With ongoing regulations around the world, corporate governance is likely to be high on the agenda. The UK's proposed regulations would require cryptocurrency companies to meet the same standards as other financial services, while the EU's cryptocurrency market directive also mandates oversight of global cryptocurrency governance.
“Obviously having an independent, non-senior officer is a good idea, it's best practice,” said John Salmon, head of digital assets and blockchain at law firm Hogan Lovells. "Eventually, however, companies will only actually commit violations when the regulations require it."
– With the help of Hannah Miller, Muyao Shen, David Pan and Suvashri Ghosh.
(1) Methodology: Companies selected for inclusion in this study meet one or more of the following criteria: are publicly traded, have a value greater than $1 billion through private fundraisers, or have significant industry impact January 2023 each company was asked the same questions and received multiple requests to participate or confirm public information between January and May 2023. The data includes information held on Silvergate Capital Corp. collected. before the banks close.
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