Blockchain has entered the mainstream, attracting the attention of investors, policymakers, and public companies. Despite its recent popularity, it didn’t appear overnight. In fact, blockchain emerged over a decade ago in 2008 to support the origin of Bitcoin, but its uses have multiplied since then. Blockchains can now be used to record many different types of transactions or contracts on a permanent ledger, usually hosted on a transparent database. It also now supports a range of digital assets, including cryptocurrencies, stablecoins and non-fungible tokens (NFTs).
Harvard Business Review noted that “true blockchain-led transformation of business and government … is still many years away.” But that hasn’t stopped public companies from incorporating blockchain and digital assets into their corporate strategies.
According to Taylor Harris, a professional practice fellow at the Center for Audit Quality (CAQ), “the use of blockchain-backed digital assets is increasing.” From a governance perspective, he noted that “companies and their audit committees must understand how they handle digital assets and related financial reporting and oversight responsibilities – including addressing a rapidly evolving regulatory environment.”
But doing so is not necessarily simple, not least because a company’s involvement in blockchain and digital assets has implications for more than just company reporting. “Digital assets are technologically complex and rapidly evolving,” Harris said, “and they affect far more than financial reporting requirements.” Harris explained that digital assets “touch on broader corporate strategy and test your cybersecurity defenses. “
While the actual day-to-day functions of digital assets and blockchains may seem granular and transactional, their nature, complexity, uses, and impact on financial reporting mean business leaders must pay attention.
“I would say that if your company is involved in digital assets in any way, there are four very important steps that management and the board should take to assess and mitigate risk,” Harris said.
“First, you need to make sure you understand the company’s goals for using digital assets. Second, you need to assess regulatory considerations – and how they might change. Third, you need to make sure you cover internal controls and reporting bases, including with audit committees and external Auditor’s discussion. In the end, you need to acquire the expertise to provide the considerable security that these assets require.”
Questions to Consider When Starting Your Digital Asset Journey
What is your main goal?
This is probably the most important of the four steps, as it drives decision making and risk assessment. CFOs and management must identify digital asset usage goals to understand whether the strategies employed will lead to the right results or to raise other questions. For example: Are they investing in Bitcoin to diversify their portfolio or to hedge against inflation? Are they prepared for financial reporting outcomes accompanying investments in cryptoassets (e.g. general intangible asset accounting under existing guidance)? Have they considered taxation, legal and regulatory requirements and how these may change in this emerging field? The sheer complexity of dealing with reporting-related digital assets can quickly get out of hand without prior thought and delving into the details.
Questions for business leaders to consider
1. What is the regulatory environment?
Currently, companies operate under existing regulatory frameworks and account for digital assets using existing accounting rules. But that is changing. “CFOs need to be aware that regulation and standard-setting are likely to change, which could affect how they interact with digital assets. It’s also important to have a global focus,” Harris said. In the U.S., regulators such as Congress and the Securities and Exchange Commission are keeping a close eye on digital assets. For example, the 118th Congress alone introduced 50 bills and resolutions related to the field of encryption, and the Department of Labor expressed concerns about whether cryptocurrency is suitable for pension plans and 401ks. That’s just a fraction of what’s going on on the Parker.
“We expect the regulator’s primary focus will be to protect consumers and investors,” Harris said.
2. What should the audit committee do?
Audit committees and auditors share a common goal: to deliver audit quality that builds trust and confidence in the capital markets. Both play leading roles in overseeing the firm’s involvement in digital assets.
First, Harris said, “audit committees need to educate chief technology officers, chief information security officers, chief financial officers, and other experts about digital assets and understand how the company uses them and how the company uses them. Second, they External auditors should be partnered to check that the company has the expertise, resources and controls in place to monitor and report on the company’s use of digital assets. They may also ask their auditors about current market dynamics and how they view the regulatory environment.
3. What are the risks?
It is important for management and audit committees to ensure they are fully engaged in another aspect: cybersecurity. Because digital assets are encoded using cryptography using private keys and are often stored in digital wallets, they face cybersecurity risks. Losing the private key means losing the associated assets. “Blockchain can become a target for bad actors,” Harris said, “and as the number of third parties, exchanges and platforms involved increases, the opportunity for these bad actors arises. Management must have processes in place and controls to address cybersecurity risks and conduct due diligence in all aspects of their digital asset involvement.” This includes working with experts and reporting on security to a degree transparently to reassure investors and the wider market.
The digital asset market continues to develop rapidly. CFOs, management, and boards of directors — especially audit committees — must be educated and engaged on the topic so they are prepared to face the latest risks and opportunities that blockchain and digital assets may present.
CAQ helps auditors and audit committees better fulfill their responsibilities.they have publish resources “Jumpstart Your Digital Assets Journey, A resource for Audit Committee Members,” which includes more information to advance your understanding of the blockchain and digital asset landscape.