The U.S. Securities and Exchange Commission (SEC) is increasing its scrutiny of audits of cryptocurrency companies in an effort to warn investors who may feel assured by audits such as proof-of-reserve reports, according to a Wall Street Journal report that cites a senior SEC official.
“Investors should not place too much confidence in the mere fact a company says it’s got a proof-of-reserves from an audit firm,” said Paul Munter, the SEC’s acting chief accountant. Having such a report “is not enough information for an investor to assess whether the company has sufficient assets to cover its liabilities,” he added.
In the aftermath of FTX's collapse, as many as nine crypto exchanges across the world announced they would publish transparency reports or Merkle tree proof-of-reserves to reassure spooked investors. A merkle tree proof-of-reserves is a cryptographic data structure that maintains privacy, but allows users to verify the stability of their holdings on exchanges, thereby creating trust.
The SEC is warning both investors and audit firms that if it finds troublesome "fact patterns," the watchdog will consider a referral to the division of enforcement, according to Munter.
The development assumes significance as questions have been swirling regarding Binance, the largest crypto exchange by trading volume, that did release a report of its proof-of-reserves but withdrew it two days later when the auditing firm it had hired, Mazars, announced it was no longer working with crypto firms.
According to the WSJ report, Binance was looking for another audit firm after it was dropped by Mazars. Binance “reached out to multiple large firms, including the Big Four (Deloitte, EY, KPMG and PwC), who are currently unwilling to conduct a [proof-of-reserves] for a private crypto company,” the company said.
Read More: Binance Losing Auditing Partner Mazars Leaves Crypto Questions Unanswered
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"We're warning investors to be very wary of some of the claims that are being made by crypto companies," said Paul Munter, SEC's acting chief accountant in an interview with the journal. The SEC did not immediately respond to a Reuters request for comment on the report. The development comes as the implosion of FTX has rippled across the industry, hobbling liquidity at firms with exposure to what was once one of the world's biggest crypto exchanges, and has prompted investigations by regulators in several countries.
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