The Breakdown - Audit Firms Don’t Want to Work With Crypto Companies, and That’s a Problem

Episode Date: December 20, 2022

This episode is sponsored by Nexo.io, Circle and Kraken.   On today’s episode, NLW catches up on the latest in the crypto industry, including: Sam Bankman-Fried changes his tune on extradition DCG-owned coins on the move Audit firms ceasing crypto operations    (CoinDesk is an independent operating subsidiary of DCG.)    - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds and keeps innovating with products like the Nexo Wallet - a non-custodial smart wallet that allows you to create your Web3 identity. Get early access at nexo.io/wallet. - Circle, the sole issuer of the trusted and reliable stablecoin USDC, is our sponsor for today’s show. USDC is a fast, cost-effective solution for global payments at internet speeds. Learn how businesses are taking advantage of these opportunities at Circle’s USDC Hub for Businesses. - Kraken, the secure, trusted digital asset exchange, is our sponsor for today's show. Kraken makes it easy to instantly buy 185+ cryptocurrencies with fast, flexible funding options. Your account is covered by regular Proof of Reserves audits, industry-leading security and award-winning Client Engagement, available 24/7. Sign up and trade today at kraken.com/breakdown. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “Glasgow” by Falls. Image credit: Feodora Chiosea/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

To the extent that crypto has to interact with the rest of the financial world, there are two ways in which they can lose their access to key infrastructure such as auditors and banking. One is regulatory for rules to change in such a way that crypto companies just can't get banked or can't get audited. But then there's also the free market way, which is exactly what we're seeing here, where the risk dramatically outweighs the reward and those independent parties aren't willing to do the work on behalf of crypto clients. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world.

The breakdown is sponsored by nexo.io, Circle, and Cracken, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, December 19th, and today we are catching up on Barry Coins, Sam Extradition, Binance, Buying Voyager, Trump NFTs, you name it, we are catching up. on it. But before we get into that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the breakers discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friend, as you can hear, I have once again succumbed to a preschool illness. However, we are not letting that get us down. You're just going to have to deal with a slightly huskier voice this time. This past weekend was extremely busy as weekends go. You

had berry coins selling, Sam extradition intrigue, an insane World Cup final, and Elon Musk pissing everyone off changing terms on Twitter, and then making a poll responsible for his future at the company. So let's see how much we can get through on today's show. Let's start with the Sam update as it's relatively small. So last week when Sam was arrested on Monday, he appeared willing to fight tooth and nail to avoid extradition to the United States, and this is kind of a common theme we've seen from him. In those Vox texts that were released that he claims he didn't know were on the record, he talked a lot about how important the Bahamas jurisdictional battle was for him. However, since having his bail denied on Tuesday and being remanded to the what appear to be

pretty appalling conditions of Foxhill Prison in the Bahamas, it seems like he might have started to change his tune. Over the weekend, Reuters reported that Sam would likely appear in court today in order to reverse his decision to contest extradition and surrender to the United States. Now, the conditions of these prisons really do seem pretty horrifying. Based on accounts we've seen from journalists as well as human rights organizations, Foxhill is characterized by overcrowding, maggot infestations, poor food quality, lack of running water, and more. A former warden called it not fit for humanity, and I read the quote from Nick Carter

last week when he said, I'm dismayed around the excitement for Sam heading to a ghastly prison where a safety can't be guaranteed. I hope U.S. authorities can ensure his safe and rapid extradition. He will face justice, but it must be done legally and with dignity. And it seems like initially after fighting that, Sam is now on that same train. Late last week, the Washington Post reported on what Sam was doing in prison using a guard as the source. He said that Sam was being held temporarily in the facility's sick bay for medical assessment

with access to much nicer amenities, including air conditioning in a proper bed. The guard said that Sam was spending his time watching movies and reading news articles about himself. According to the report, Sam was still holding out hope that he would be granted bail at a second hearing, and leave the prison soon. When the guard asked Sam how he felt watching a news report about himself, Sam answered, it's okay, I will deal with it. To me, it seems he's still a little bit delusional about the situation he finds himself in. Overall, the guard described Sam as, quote, a little arrogant, but overall, a nice guy who has kept to himself and seemed, quote, awfully scared during his first days at the prison. Now, before today, Sam's extradition hearing was scheduled to begin on February

8th of next year. However, the Reuters report said that Sam decided to surrender to the U.S. on Saturday. Sam be extradited to the U.S., he would likely be held at the Metropolitan Detention Center in Brooklyn, pending a bail hearing which must happen within 48 hours of his arrival. Former federal prosecutor and white-collar defense attorney Michael Weinstein said, The missing money gives prosecutors strong arguments that he is a flight risk. I expect that if a judge grants pretrial release, they would impose very restrictive and onerous conditions. Legal experts anticipate that a full trial would still be more than a year away if no plea deal

is reached and if Sam defends the charges. According to former CFTC trial lawyer Braden Perry, Sam could face being sentenced to life in prison as well as being barred from financial markets by regulators. Former federal prosecutor Duncan Levin said usually white-collar cases of this magnitude are under investigation for months, if not years, and then cooperators are used to build a case from the ground up. It's unlikely the government even had time to develop any cooperator testimony. The government is certainly basing its case on a torrent of bank and other financial records. Now, since I started recording this segment, we've gotten some updates from eyewitness news, Bahamas, quote, An emergency hearing for disgraced FTCFounder Sam Bankman-Fried was forced to take a 45-minute recess after his lawyers told him magistrate his appearance this morning was, quote, shocking and premature.

SBF's counsel, Jerome Roberts, told the magistrate that he has not yet made any formal request for his client to appear in court. Sources close to the matter confirmed to eyewitness news that SBF had changed his mind and would appear in court today to advise that he will no longer fight extradition charges to return to the United States. However, Roberts told the justice that he was not aware his client would be at court. The New York Times picks up from here quoting Mr. Roberts, saying, Whatever trail got him here this morning, it did not involve me. So who knows what's going on, but Sam appears to be so hungry to get extradited to the U.S. at this point

that he's heading to court without even talking to one of his lawyers. In an ecosystem where innovation is the norm, it's the basics that are in the same. spotlight. Nexo is a company that has never put the safety of clients' funds in question. With over 50 global licenses, $775 million in insurance, and a real-time audit of custodial assets, Nexo sets an example for security standards in the industry. Apart from keeping their 5 million clients safe, Nexo has kept building. They've just announced their non-custodial smart wallet. Visit nexo.io. That's nexo.io and sign up today. This episode is brought to you by Circle, the sole issuer of USDC, and a leader in crypto that's held to a higher standard.

USDC is a fast, safe, and efficient way to send money around the globe. USDC is always redeemable one-to-one for U.S. dollars, and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to Circle.com backslash transparency to see why USDA is a trusted stable coin. Cracken Pro is an all-new, powerful trading experience for advanced traders. Spot trade, margin trade, and stake, all from a single interface.

With customization tools, unlike any other, Cracken Pro lets you set up your trading interface in the exact way you want. It's all backed by Cracken's industry leading security and award-winning client engagement teams that are available for support 24-7. No matter how you like to trade, Cracken Pro is built to make it happen. Pro.crakken.com or download the CrackenPro app on Google Play or the Apple App Store today. Let's talk about the unceremonious exit of auditors from the crypto space. Mazars, the audit firm who recently completed a proof of reserves report for Binance,

said on Friday that it will halt all work for crypto clients. The firm deleted its website, which hosts crypto firm reports, including the Binance Report, which only covered Bitcoin holdings, as well as reports for Ku-coin and Crypto.com. Mazar said that it was taking this step, quote, due to concerns regarding the way these reports are understood by the public. When the Binance report was released almost two weeks ago, many commentators criticized Binance for characterizing the report as an audit, even though the report was not thorough enough to be considered as an audit.

Importantly, this appears to be a trend. Arminino, another auditing firm, has also reportedly halted work for its crypto clients. Arminino had been an auditor for FTX U.S. and was recently named in a class action lawsuit launched by an FtX customer. This has led to speculation that the refusal of crypto audit business was in part a demand of other clients, who may have seen the fallout in crypto as having potential to damage the legitimacy of other audits conducted by the firm. One more, BDO, the audit firm which has been conducting the most recent Tether Reserve attestations, has also announced that it will be reconsidering its

crypto business. Now, a big part of this is that auditing is primarily a business of reputation, so becoming entangled in the failures across the crypto industry could be simply too risky for auditors. Mazzars had previously tried to get around this by claiming that their crypto reports, quote, do not constitute either an assurance or an audit opinion on subject matter. Instead, they report limited findings based on the agreed procedures performed by the subject matter at a historical point in time. In other words, they don't want to be mentioned in the headlines as the firm who signed off on an insolvent crypto firm. Now, there is a cynical take on all this, which is that the things that crypto firms ask for from auditors aren't actually real audits.

Jacob Silverman tweets, Accounting firms like Mazzars, Arminino, and BDO that were doing non-audit attestations, proof of reserves, some third thing they made up for Binance, FTCS tether, at all, are pulling out of crypto entirely. However, there's also a less cynical take that audit firms aren't set up to do the full, on-chain sort of

proof of reserves that the crypto community is increasingly demanding from centralized custodians. And what's more, that audit firms are incredibly risk-averse and crypto now comes with serious PR risk. Nick Carter tweets, consistent with what I've seen, audit firms are insanely risk-averse and very few are willing to do proof of reserves for anyone. Not a crypto-exchange sketchiness thing, more of an audit firms are crazy risk-averse thing.

The Arminino FTX-U-S fallout has every single audit firm reconsidering crypto-exchange relationships. Insurance premium for auditors are up too. Many crypto exchanges just won't be able to get anything now. Yes, Mazars deleted their proof-of-reserves, A-U-P. Is this evidence that proof-of-reserves is rotten? No. Mazar's pulling back from crypto-audits is likely due to bad PR, and the parents' parent org asking the South Africa branch to cool it. Armadino also pulled out of crypto audits.

Doesn't mean proof of reserves is fake, means audit firms are getting risk-averse post-FTX. Now, I do think that this is a huge issue. To the extent that crypto has to interact with the rest of the financial world, there are two ways in which they can lose their access to key infrastructure such as auditors and banking. One is regulatory for rules to change in such a way that crypto companies just can't get banked or can't get audited. But then there's also the free market way which is exactly what we're seeing here, where the risk dramatically outweighs the reward, and those independent parties aren't willing to do the work on behalf of crypto clients. This is a real damnable and intractable problem,

because by definition it requires some firm taking some amount of industry risk or some individual putting themselves out there with career risk to argue for it to try to be the one firm that's willing to do it. And clearly that hasn't served these auditors that well, or at least that's how they're feeling right now. Staying on Fallout from FTX, one of the big things that people have been waiting for is clarity on what's happening with Genesis and DCG. Remember, Genesis lending disabled withdrawals about a month ago, and people aren't

sure if the contagion ends with them or is going to extend all the way up into its parent company Digital Currency Group, which also owns CoinDesk. However, on Friday, around the time that U.S. equity trading closed, something weird started happening. Multiple cryptocurrencies either held in DCG Exchange traded products or previously mentioned by CEO Barry Silbert, went into significant slides. File coin dropped by 23%, Ethereum Classic dropped by 6.8%, and Decentraland's mana token tumbled by 10% over the course of about an hour. Now, the curious part of this is that the markets moved on no news, indicating that it was more likely to be a behind-the-scenes liquidation of some sort. This has led to, of course, rampant speculation on crypto-Twitter about what caused

the collapse of the so-called Barry coins. Deep-effing Defi writes, this sell-off looks like Binance Fudd at the surface level, but Barry and DCG may be dumping their asses. sets and potentially going under. They have been way too quiet. DCG going down would likely be final capitulation. They were the biggest. Shocking if they fumbled the bag. Wizards of Soho writes, I step away for five minutes to frickin' make dinner and Barry starts dumping every alt-coin in existence. Jesus Lord, who dumps on a late Friday when all liquidity is off ahead of Christmas? Seriously, the investors and big founders in this space before 2020 are literally great A clowns. Now, the reality is we don't have any good information about what's actually happened. It's all just

speculation. However, I will note that the context and the environment in which speculation like this thrives is one in which the principles that are being speculated about haven't commented themselves. By which I mean, if you're wondering, if I think that Genesis and DCG should be saying more, the answer is yes, I do. Anyway, I guess on that front, this morning we did get an end-of-year CEO note from Grayscale that discussed some of these issues. TLDR, Grayscale still wants to convert the Bitcoin Trust to a spot Bitcoin ETF, but if they can't, they're exploring other options. from the Wall Street Journal, quote, These options could include a tender offer for up to 20% of the outstanding shares of the $10.7 billion trust.

A tender offer would make a direct appeal to shareholders to sell or tender their shares at a specific price during a certain time. Now, this isn't really the clarity that people were hoping for, but something at least. Barry Silbert tweeted the story out, his first tweet in weeks, to which Udi Wertheimer responded, Hey, Barry, how are you, my man? Barry responded to that, looking forward to getting this year behind us, which I think many can heartily. agree with. Binance was also in the news. As of this morning, Binance U.S. has entered into agreement with Voyager to purchase Voyager for just over $1 billion. The deal is basically the fair market value

of Voyager's assets plus $20 million in incremental value. Voyager said in a statement, the Binance U.S. bid aims to return crypto to customers inclined in accordance with court-approved disbursements and platform capabilities. Now, you'll remember that FTX US had won the bid for Voyager previous. And speaking of FTCS, color the market skeptical of this deal. Ben Hunt writes, you do this deal for the same reason FTCS quote-unquote bought BlockFi and Voyager. It's cheap, no other bids, and there's a loan on the books you don't want called. Genevieve Roch Dexter writes, Binance is spending over $1 billion to buy bankrupt crypto exchange Voyager as questions about Binance's reserves and liquidity are being raised. Scott Melko writes,

Binance U.S. is acquiring Voyager. Voyager managed to secure a shittier deal than even from FTX, from another company subjected to massive FUD. Asset buyout plus 20 million. FTX's bid was 100 million. Finance already had bid 50 million in original auction. Disappointing. So you can kind of get a vibe from all of this about where everyone is. It is still a moment where we just want to know what shoes are left to drop, who else is financially imperiled, and what the hell it's going to take to move on. The reality is that in many cases, there aren't easier short answers. And a lot of the beginning of 2023 is going to look like a more

slogged out, boring, frustrating, unfun version of the end of 2022. However, I guess if the choice is boring cleanup versus more cataclysm, I'll take the boring cleanup. For now, I want to say thanks again to my sponsors, nexus.io, circle and crackin. And thanks to you guys

for listening. Until tomorrow, be safe and take care of each other. Peace.