Crypto’s Most Influential Companies Often Follow Their Own Rules

Its sister trading firm Alameda Research, which reportedly received unrestricted access to FTX client assets to fund its bets, had such poor record keeping that Bankman-Fried told staff members its books were “unauditable”, according to communications published by the new management of the group. the company would find $50 million in assets “lounging around that we’ve lost track of,” Bankman-Fried said. Now the former CEO is accused of fraud, money laundering and bribery of Chinese officials – among other charges – while investors and customers suffer billions of dollars in losses.

The lack of effective corporate governance and due diligence conducted on FTX’s books has raised eyebrows around the world. But for crypto industry watchers, this is not an unfamiliar story.

Bloomberg News surveyed 60 major crypto companies in the first quarter – spanning all exchanges, mining firms, analytics firms and token issuers – to assess the state of governance and controls in the industry. (1) like Binance, Coinbase Global Inc., Tether and OpenSea, oversee the flow of tens of billions of dollars of assets daily. And while many adhere to traditional norms, many operate outside the norm.

Each was given the same set of questions, aimed at measuring how much of crypto’s upper echelon employs a third-party auditor and has an independent board of directors. More than half of the companies provided full or partial responses, while 17 declined to participate and eight did not respond at all. For some who refused, this information was publicly available.

“It’s an industry of anonymity masquerading as transparency”

About half of the companies surveyed currently hire an independent auditor to assess their finances, according to the findings. Meanwhile, 63% of companies had an independent board – meaning they had at least one non-executive member. Almost all of the 60 companies surveyed have raised outside investment since inception, according to PitchBook or other publicly available information.

Independent audits and boards of directors are basic standards that any investor would expect a company to have in place, particularly if that company is of a certain size and operates in a financial sector, said Ruth Foxe Blader, Digital Financial Services Venture Capital Partner. Anthemis company. But when it comes to crypto – a sector whose technology promises openness and indelible record keeping – the industry as a whole has failed to secure such accountability.

“It’s an industry of anonymity masquerading as transparency,” Ruth Foxe Blader, a partner at digital financial services venture capital firm Anthemis, said in an interview.

Changing investor expectations

Crypto is a young industry: only a handful of the 60 companies are publicly traded and subject to certain regulatory standards. Disclosure requirements can differ globally, and a lack of openness doesn’t necessarily mean there’s something to hide. But the recent spate of crypto scandals, alongside a broader decline in venture capital investment, has upped the ante.

Some investors thus become more demanding and vigilant. Regulators are also concerned, with a recent proposal from the New York State Attorney General suggesting that crypto exchanges be required to seek independent public audits.

While it’s typical for a startup to have only its founders on the board during a seed investment, it should have at least one outside director during its Series A cycle, says David Pakman , managing partner of crypto-VC firm CoinFund.

“That’s what we expect now,” he said, noting that crypto investors are increasingly aligning their expectations with the standards they need for traditional tech venture capital funding. For late-stage tech companies, board approval is required for spending above a certain level, he added, another expectation “that also goes into crypto.”

Audit pains

Audits have become a hot topic for the crypto industry in recent years. While startups might be highly regarded by investors without necessarily generating enough revenue to warrant financial review, investors generally expect an audit once a company hits around $20 million in annual revenue, according to the General Partner of Balderton Capital, Rana Yared.

Many crypto companies have said that big auditing firms are hesitant to engage with them, in part due to a perceived lack of experience with blockchain accounting and a history of scams and scandals. the crypto industry. Several firms, including crypto exchanges Binance and Bitfinex, said in their responses that the Big Four accounting firms are unwilling or unequipped to work with digital asset companies like theirs.

Survey results show that about 46% of the 24 companies that disclosed information about their current auditor said their full financial audits were performed by a Big Four accountant. Coinbase, Circle and Ripple said they received annual audits from Deloitte, while EY was appointed as an auditor by Chainalysis, Ledger and Anchorage Digital. Most companies had also been subject to continuous external checks on their finances for at least three years.

Some audit firms have become reluctant to work with industry. France-headquartered Mazars Group, which previously provided reports attesting to assets held in reserve by stock exchanges Binance and Crypto.com, halted all such work in December citing “concerns about the manner in which these reports are understood by the public”. Binance and Crypto. .com has since hired new listeners, according to company spokespersons, who declined to disclose which ones.

Empty meeting rooms

Without the extensive regulatory framework that is present in other areas of finance, investors and pundits said there was little impetus for some crypto firms to catch up.

Listed companies are required to have a board of directors as a condition of trading in destinations such as the US, UK and EU, but startups will often form boards before that point. , as venture capitalists usually ask for a seat as a condition. of investment.

While 38 of the surveyed crypto companies had a board of directors with at least one non-executive member, the results showed that 10 companies did not, while 12 did not answer this question or the information were not available in public documents. Among those without an independent board were Tether, Huobi, and Magic Eden, whose board was either advisory only or comprised entirely of corporate executives.

Binance will likely have a formal board in place to oversee its parent group by the end of this year as it seeks registration with regulators around the world, the exchange’s compliance officer has said. , Noah Perlman, in an interview.

However, not all crypto companies are the ones that handle customer money, which dampens the impetus for stronger corporate governance from the start. Some companies said they have a board of directors but declined to confirm information about its members, such as Crypto.com, Kraken, Uniswap Labs and OpenSea.

There’s also no guarantee that having a board can help stave off corporate delinquency, Foxe Blader and Yared said, with the tech and finance sectors hosting their own explosions. of business.

With ongoing regulation around the world, corporate governance is likely to be high on the agenda. Proposed rules in the UK will require crypto companies to meet the same standards as the rest of financial services, while the EU’s Crypto Asset Markets Directive also plans to oversee governance within crypto companies operating within the world. block.

“It’s clear that having independent non-executives is a good idea, it’s best practice,” said John Salmon, head of digital assets and blockchain practice at law firm Hogan Lovells. they have to.”

–With help from Hannah Miller, Muyao Shen, David Pan and Suvashree Ghosh.

(1) Methodology: Companies selected for inclusion in the study met one or more of the following criteria: they are publicly listed, have been valued at more than $1 billion in private fundraising, or have been considered with significant industry influence as of January 2023 Each company was asked the same set of questions and received multiple requests to participate or confirm public information between January and May 2023. Data includes information collected on Silvergate Capital Corp. before the bank closed.