When cryptocurrency promoters tried to convince gullible investors that their money was safe, a challenge was to demonstrate that the real assets allegedly backing crypto creations actually existed. Since this was uncharted territory, they had to get inventive.
Thus, a completely new self-regulation concept called “proof of reserves”, or PoR, was born. Ostensibly, a PoR certification, which has no basis in securities law or any other form of law, is an independent audit that confirms that the money is allegedly where the crypto promoter says it is.
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But given the chronically dubious claims about crypto and the serial lies told by Sam Bankman-Fried and others, there was good reason to be skeptical. Now it turns out that these supposedly independent audits are no more reliable than the crypto itself.
The Public Company Accounting Oversight Board (PCAOB) has issued a public warning that reserve audit evidence is completely unregulated and not reliable. The warning says:
The [PCAOB] The Office of the Investor Advocate is issuing this investor notice out of concern that investors and others may place undue reliance on PoR reports, which are not within the PCAOB’s oversight authority. Importantly, investors should note that PoR engagements are not audits and, accordingly, the related reports do not give some meaningful assurance to investors or the public.
This raises the larger problem of self-regulation, which by definition is fraught with conflicts of interest. The reason we have public regulation, by regulators like the SEC, is because promoters and their employees cannot be trusted to be honest.
Before the PCAOB was created by the Sarbanes-Oxley Act of 2002, the accounting profession was trusted to certify the accuracy of corporate books. Oversight of the accountants was, in turn, delegated to their own trade association, the American Institute of Certified Public Accountants, a classic case of the fox guarding the henhouse.
In the 2001 Enron scandal (repeated by others such as WorldCom and Tyco International), independent accountants allegedly colluded with management to fabricate the company’s books. When Enron collapsed in a sea of corruption, the scandal also took down the accountants, the venerable firm of Arthur Andersen, who were later convicted of obstruction of justice. In the wake of Enron, the Sarbanes-Oxley Act tightened accounting standards and established the PCAOB as an arm’s-length supervisor of the accounting profession.
Meanwhile, the rolling crypto collapse continues to reverberate. At first, it appeared that crypto was not directly involved in last Friday’s implosion of Silicon Valley Bank (SVB). But then it came out that Circle, a crypto company that issues stablecoins, had $3.3 billion of its reserves on deposit at Silicon Valley Bank. The market value of the stablecoin, called USDC, allegedly pegged to the US dollar, quickly fell well below par.
The supposedly independent certification by Grant Thornton Group of the solvency of Circle’s assets, in a PoR report issued in January, was suddenly worthless. And the volatility of other crypto startups in the Valley fueled the bank run that crashed SVP.
How many times do we have to learn that the soundness of the financial sector is only as reliable as its independent regulators?
