Auditability Digital Assets

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Auditability of Digital
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June 4, 2019
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Auditability of Digital
Assets
June 4, 2019
2pm EST
Speakers
Markus Veith Jeremy Goss

Partner in charge of the Northeast Senior Manager
Financial Institutions Practice Grant Thornton LLP
Grant Thornton LLP Jeremy.goss@us.gt.com
markus.veith@us.gt.com
© 2018 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 5
Learning objectives
Describe the basics of blockchain technology and state

1 the most prevalent current use cases
Define the unique characteristics of holding and

2 safeguarding digital assets in the form of
cryptocurrency
Summarize the risks, challenges and best practices in

3 auditing digital assets

“A purely peer-to-peer version of electronic cash would allow
online payments to be sent directly from one party to another
without going through a financial institution.”
How the anonymous bitcoin inventor Satoshi Nakamoto began his

famous white paper.
https://bitcoin.org/bitcoin.pdf
7
Contents
Section Page
Blockchain Basics 4
Crypto Currencies: Bitcoin 13
Audit Approach 19
European FS snapshot 2017 8

Blockchain Basics
Blockchain Basics Sylvain Theveniaud “The idea is to work with Everledger and
make [proofs-of-concept] and use cases
Quotes, Hype, Context Allianz Accelerator
Managing Director
that we can experiment with inside
Allianz.”
Donald J. Duet “Blockchain has ability to provide a "single truth" to
Goldman Sachs the many institutions that need to share information
Co-head of on asset transfers”.
David Walker
technology and "Blockchain is an important advance in
managing director Bank of England
settlement technology and Setl has a
Former executive compelling proposition for its deployment."
director
Blythe Masters "Digital Assets has a revolutionary technology

JP Morgan platform that eliminates the counterparty risk and
• Former head of lack of transparency that has hindered mainstream “All our business lines are involved here.
global commodities adoption of cryptographic technology. The The transaction services organization
• CEO Digital Assets possibilities for reducing cost and risk in settlement Mark Buitenhek which I am heading for ING globally, our
Holding are enormous." ING financial markets, our lending services
Global Head of department is involved. There are people
Transaction from IT involved, people from operations,
Services client coverage staff.”
Mark Walport "Distributed ledger technologies have the potential
to help governments to collect taxes, deliver
Government of the UK benefits, issue passports, record land registries,
assure the supply chain of goods and generally Oliver Bussmann "UBS is proud to contribute to the HEAL
Government Chief Bond on Blockchain and agreed to share
ensure the integrity of government records and UBS Group
services." Chief Information the learnings of its 'Smart Bond'
Scientific Adviser experiment with the HEAL Alliance.”
Officer

Blockchain Basics
What does the ecosystem look like today?

Blockchain Basics

Blockchain Basics
 The Blockchain is a ledger  Transactions are continuously
validated by the whole network
 Distributed through multiple

servers (nodes)
 Enables its participants to transact

any assets among themselves
 Transactions are grouped into blocks.

 No need for a third party to verify Once a transaction is added to a
those transactions block it becomes immutable.

Blockchain Basics
 The Blockchain is a distributed ledger that records financial (or non-financial) transactions between two participants (peer-
to-peer), without the need for an intermediary verifying those transactions. Verifying the identity of the parties is made by
cryptography.
 Basics
• The blockchain’s ledger is distributed and replicated throughout the whole network.
• The information recorded is grouped through blocks and it is immutable once it is recorded.
• Once the information is registered through a transaction it will be unforgeable.
• The blockchain database contains every single transaction since the creation of the blockchain.
• A blockchain can be: public (fully decentralized), permissioned (partially decentralized) or private (centralized).

Blockchain Basics
Sample Use Cases

Crypto Currencies:
Bitcoin
Getting Started with Cryptocurrency:
How do I acquire/use Bitcoin?
Basics (acquisition and transmittal):
• Create a Bitcoin wallet.
• Usually, you link a traditional account (e.g., bank) to an exchange (e.g., Coinbase) account, and "purchase" bitcoin with
actual currency
• The wallet holds the private key(s) used to prove you own specific Bitcoins.
• The software creates public/private key pairs for you as needed.
• For each private/public key pair, there is a corresponding bitcoin address, which is a 160-bit hash of the public key.
• Bitcoins are sent from and to specified and individuated addresses.
• The wallet also contains software that allows you to send and receive bitcoins.
• You send bitcoins by registering your payments within the Bitcoin blockchain, Bitcoin’s public ledger that contains all
transactions since the advent of bitcoin.

How are Bitcoin transactions recorded?
Basics (mining and the blockchain ledger):
• Approximately every ten minutes or so, one lucky bitcoin miner earns a reward for extending the block chain by one
block.
• In 2009, the reward was 50 BTC. Today it is 12.5 BTC.
• See https://blockchain.info/q for details on issuing blockchain queries.
• Mining is the only mechanism for creating new bitcoins.
• The total number of Bitcoins will never exceed 21M, thereby fixing a ceiling and establishing a scarcity and
helping to "stabilize" value.
• The rewarded miner also receives all (optional) transaction fees in the block.

How do I safeguard Bitcoin? What are the risks?
Storage Basics: Risks:

• Theft
• Online exchanges
• Lost keys
• Wallets
• Lost memory
• Transfer money back to bank account
• EMP Event / Hardware Failure
• Convert to other currencies
• Exchange Collapse
• Hardware Wallet (e.g., Trezor)
• Value collapse
• Hacking

How are cryptocurrencies accounted for?
Accounting for Cryptocurrencies:
• There is currently no formal authoritative accounting guidance in IFRS and US GAAP
• In September 2015, the United States Commodities Futures Trading Commission (CFTC) asserted for the first time that bitcoin is
a “commodity”
Current views on how to account for cryptocurrencies are as follows:
IFRS:
• Intangible Assets under IAS 38 either at cost or revaluation (if active market exists)
• (Under limited circumstances) Inventories under IAS 2 either at lower of cost and net realizable value or if the entity actively
trades cryptos at FV less cost to sell with changes in FV recognized in P&L
US GAAP:
• If actively traded, could be viewed akin to 'precious metals' recorded at FV with changes in FV recognized in P&L
• If no active market exists, as intangible assets measured at cost less impairment

Audit Approach
Audit Risk Considerations
Accuracy of books and records
Effectiveness of internal controls (including ITGCs)
Wes Bricker,
Chief Accountant, SEC Custody (in-house, third parties, hot/cold/warm)
(From speech 9/17/18)
Ownership and identity (e.g. related parties)
Loss contingencies and NOCLAR
Audit Risk Considerations (continued)
Assertions
Existence Ownership Valuation
• Comparisons of point-in-time • Message signing and other • Reliability of pricing sources

unit balances to public block methods of proof of ownership • Limited volumes
Considerations
chains • Customer funds vs. Company • Leveling assumptions

• Confirmation with third funds • Market manipulation
parties • Inherent limitations of assets
• Inherent limitations of assets (e.g. privacy coins)
(e.g. privacy coins)
Completeness and Accuracy of the Underlying Information
Used to Produce Financial Statements
Auditing Crypto Currency
Introduction
Primary concerns of the crypto audit:
• Existence
• Ownership Crypto Assets
• Valuation

What do you test and why?
When GT tests Bitcoin holdings we test three elements:
Existence Does the address(es) purportedly owned by the client exist?
BTC Balance Does the point in time balance match our clients’ records?
Ownership Does the client have sufficient control over the address to make a transaction?

Existence Testing - Bitcoin
GT extracts the following data from the

blockchain using its proprietary BTC node
analysis application: 100,000 BTC
Addresses
1. Address summary data, and;

2. The transaction details for every
transaction;
3. Successful extraction confirms the address 500 GB Database
existence

Ownership Testing - Bitcoin
A 2-Step Verification Process:
1. Signature:
a)GT provides the Company with a message to sign for each selected address
b)Company cryptographically “signs” the message resulting with the signature
c)GT performs this validation via a combination of the public address, message, resulting
signature, and our BTC infrastructure
2. Verification:
If the verify command returns TRUE, then the signature was created with the associated private key. If
the verify command returns FALSE, then the signature was not created with the associated private key.
Note: Another risk that we address elsewhere in the program is if the entity has access to other
private keys.

Ownership Testing - Bitcoin
To use cryptography to test ownership the owner needs three things, their public
address, a message to be signed, and access to their private key.
With those items they can generate something that looks like this:
HyK03MaLi62g3ck/SQ6xfbbHQ4PqUOvf4R6MHIVW0L/bfhfPBHhA7OsQkEnE
G0MqrDLifONvLmp1IH/c6kj69bY=
Then, crypto-magic!

Valuation Testing - Bitcoin
Step 1: Audit teams utilize GT’s Bitcoin Infrastructure as of 12/31/20XX at

11:59PM to verify the existing units of BTC at year end
Step 2: Audit teams uses a third party pricing source (e.g. Coindesk,
CoinMarketCap, specific exchange) to verify the value of BTC at year end
Note: Value of BTC (and other digital asset classes) may need to be audited
like any other Level 3 asset. This will be driven by trading frequency.

Valuation Testing - Bitcoin
The value of a Bitcoin in US Dollars can be verified using one of the many Bitcoin exchanges.
A Bitcoin exchange is a website that allows entities to buy and sell Bitcoins in an open marketplace.
The exchange selected should have a strong reputation, security record, and support by major investors. For
example, Coinbase has raised more than $100 million in investments from venture capitalists.
Each day, there are on average over 140,000 transactions on Coinbase and that volume has continued to
increase.
Exchanges observed often have vastly differently pricing, where arbitrage opportunities exist and the markets
are inefficient. As such, the Company’s “principal market,” as defined by GAAP is the relevant market for
reasonable fair value pricing.

Audit Best Practices – Acceptance
Companies should be prepared for heightened level
1 of auditor inquiry, information requests and due
diligence prior to client acceptance by the auditor
Encourage open and honest communication with
2 auditors regarding management’s objectives, business
plans, markets and growth strategies
Involve executive management and those charged

3 with governance in client acceptance discussions to
the extent practical
If changing auditors, companies should be prepared to

4 discuss prior year findings, remediation efforts,
and other issues encountered during the audit
Audit Best Practices – Fieldwork
Identify complex issues early and determine
1 accounting treatments (e.g. broker/dealer accounting,
on/off balance sheet, gross/net revenue, etc.)
Discuss with auditors the entity’s IT general controls,
2 complexity of IT systems and the ability to rely on
control environment. If outsourced, discuss availability
of service auditors reports
Discuss the auditor’s planned procedures and
3 methodology for testing existence and ownership
of digital assets, including third party custodians
Schedule regular status meetings to identify and

4 address issues in real time, as well as monitor multiple
audit team workflows (e.g. core audit team, technical
team, IT controls team, national reviewers, etc.)
Contact Information
Markus Veith
Partner-in-charge of the Northeast Financial Institutions
Practice
Markus is the Partner-in-Charge of the Metro New York & New England Financial Institutions Practice and Education
an SEC, IFRS and blockchain technology specialists. He has over 20 years of experience in banking and
public accounting. • M.S., Taxation and Accounting, Pforzheim University, Germany
• M.B.A., Fordham Graduate School of Business
Experience
Other credentials
• Markus leads audit engagements of both public and private financial services organizations ranging
from large multinational institutions to local FDIC-insured banks and federal credit unions. He also led • Licensed as a CPA in New York, California, Massachusetts and North Carolina
consulting projects on loan reviews, operational process reviews, post-merger integration, due • AICPA Revenue Recognition Special Task Force
diligence and asset securitization. Other areas of concentration include capital raises and IPOs. He • Banking Committee of the New York State Society of Certified Public Accountants
also works and assists other offices with IFRS audits, reviews and conversions. • American Institute of Certified Public Accountants (AICPA)
• Institute of International Bankers
Industry experience • New York State Society of Certified Public Accountants (NYSSCPA)
• He has worked with banks, securities and commodities broker/dealers, REITs, BDCs, private equity Presentations and publications
groups, finance and investment companies. His clients include companies with multistate and
multinational operations. • Markus presents frequently to industry groups and at internal training courses. He also regularly
speaks to trade groups and the business press. Markus was quoted extensively on the Financial
• Prior to joining Grant Thornton LLP, Markus worked for Deloitte and McGladrey. He began his career Reform Act in a recent article titled “The Shape of Things to Come,” in The Deal. One of his articles
in Europe with a regional savings bank affiliated with DZ BANK AG – one of Europe’s leading on the Financial Reform Act was also published in a recent industry newsletter.
financial organizations.
Contact details
T: 212.624.5370
E: Markus.Veith@us.gt.com

Contact Information
Jeremy Goss
Senior Manager, Financial Services
Jeremy has more than 15 years of accounting and auditing experience serving financial institutions and Education
other financial services companies. Jeremy’s experience includes leading teams in audit and consulting
services for public and private financial institutions, financial technology, specialty finance entities, asset • Bachelor of Science in Accounting, Arkansas Tech University
managers, credit card companies and real estate investment trusts. • Masters of Business Administration, University of Arkansas at Little Rock
Experience Other credentials
• His digital assets experience includes leading teams in financial statement audits, technical • American Institute of Certified Public Accountants (AICPA)
accounting advisory, development of internal control over financial reporting and back-office • New York State Society of CPAs – Banking Committee Chair
accounting services for financial technology trading and asset management firms with billions in • AICPA Digital Assets Working Group
assets under management. • Association of Certified Anti-Money Laundering Specialists (ACAMS)
• Jeremy has extensive experience in accounting consulting and research using U.S. GAAP via the Presentations and publications
FASB Accounting Standards Codification, specifically as it relates to issues facing the financial
services and financial technology industries. • Jeremy routinely delivers continuing education technical sessions on the new current expected credit
loss (CECL), financial instruments and revenue recognition standards which become applicable for
• He assists banking and financial services clients with regulatory compliance (e.g. FFIEC, CCAR, financial services companies currently and in the coming years.
DFAST, SEC), mergers and acquisitions, initial public offerings, private stock offerings, internal
controls (e.g. FDICIA, SOX 404), loan reviews and technical accounting matters. Contact details
• Additionally, Jeremy is experienced in credit risk evaluation of wholesale and retail loan portfolios. His T: 212.624.5295
experience includes detailed analysis of the methodologies, calculations and rationale used in E: Jeremy.Goss@us.gt.com
determining appropriate levels of allowance for loan losses and providing feedback where deviations
exist from established principles, regulatory guidelines and industry practice.

Any final questions?
Disclaimer
• This Grant Thornton LLP presentation is not a comprehensive analysis of
the subject matters covered and may include proposed guidance that is
subject to change before it is issued in final form. All relevant facts and
circumstances, including the pertinent authoritative literature, need to be
considered to arrive at conclusions that comply with matters addressed in
this presentation. The views and interpretations expressed in the
presentation are those of the presenters and the presentation is not intended
to provide accounting or other advice or guidance with respect to the matters
covered
For additional information on matters covered in this presentation, contact
your Grant Thornton LLP adviser
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Click the Resources button to download the presentation materials

© Grant Thornton LLP. All rights reserved. 3

Markus Veith Jeremy Goss

Describe the basics of blockchain technology and state

Define the unique characteristics of holding and

Summarize the risks, challenges and best practices in

© Grant Thornton LLP. All rights reserved. 6

How the anonymous bitcoin inventor Satoshi Nakamoto began his

European FS snapshot 2017 8

Blythe Masters "Digital Assets has a revolutionary technology

© Grant Thornton LLP. All rights reserved. 11

© Grant Thornton LLP. All rights reserved. 12

© Grant Thornton LLP. All rights reserved. 13

 Distributed through multiple

 Enables its participants to transact

 Transactions are grouped into blocks.

© Grant Thornton LLP. All rights reserved. 14

• Once the information is registered through a transaction it will be unforgeable.

© Grant Thornton LLP. All rights reserved. 15

© Grant Thornton LLP. All rights reserved. 16

© Grant Thornton LLP. All rights reserved. 18

• In 2009, the reward was 50 BTC. Today it is 12.5 BTC.

• See https://blockchain.info/q for details on issuing blockchain queries.

• Mining is the only mechanism for creating new bitcoins.

© Grant Thornton LLP. All rights reserved. 19

Storage Basics: Risks:

© Grant Thornton LLP. All rights reserved. 20

© Grant Thornton LLP. All rights reserved. 21

Accuracy of books and records

Effectiveness of internal controls (including ITGCs)

Ownership and identity (e.g. related parties)

Loss contingencies and NOCLAR

Existence Ownership Valuation

• Comparisons of point-in-time • Message signing and other • Reliability of pricing sources

chains • Customer funds vs. Company • Leveling assumptions

Primary concerns of the crypto audit:

© Grant Thornton LLP. All rights reserved. 25

When GT tests Bitcoin holdings we test three elements:

Existence Does the address(es) purportedly owned by the client exist?

© Grant Thornton LLP. All rights reserved. 26

GT extracts the following data from the

1. Address summary data, and;

© Grant Thornton LLP. All rights reserved. 27

A 2-Step Verification Process:

© Grant Thornton LLP. All rights reserved. 28

© Grant Thornton LLP. All rights reserved. 29

Step 1: Audit teams utilize GT’s Bitcoin Infrastructure as of 12/31/20XX at

© Grant Thornton LLP. All rights reserved. 30

© Grant Thornton LLP. All rights reserved. 31

Involve executive management and those charged

If changing auditors, companies should be prepared to

Schedule regular status meetings to identify and

© Grant Thornton LLP. All rights reserved. 34

Experience Other credentials

© Grant Thornton LLP. All rights reserved. 35

© Grant Thornton LLP. All rights reserved. 39

www.grantthornton.com twitter.com/GrantThorntonUS linkd.in/GrantThorntonUS

© Grant Thornton LLP. All rights reserved. 40