Assuring Trustworthy Crypto Exchanges: The Crucial Role of External and Internal Audits in Mitigating Fraud and Ensuring Financial Accuracy

Posted in Crypto Asset Compliance, Internal Audit on May 20, 2024
Assuring Trustworthy Crypto Exchanges

Assuring trustworthy crypto exchanges, the indispensable roles of both internal and external audits come to the forefront, as they work hand in hand to establish financial accuracy, mitigate fraud, and bolster investor confidence in this rapidly evolving digital marketplace.

An audit assures the Board of Directors and Shareholders of crypto exchanges or institutions regarding the reliability of the internal controls system and financial statements of the organization.

Shareholders trust the third-party assurance, therefore, external auditors are appointed to perform an audit of the financial statements, of crypto exchanges or institutions, prepared by the management. 

External auditors being the third party and independent, perform such audits and provide audit reports for consideration of the shareholders. 

The internal audit department of crypto exchanges or institutions performs audits of crypto operations controls and reports to the Board Audit Committee. The internal audit does not participate in the crypto business decision-making and operational processes, however, it checks the control’s sufficiency and operating effectiveness.  

Both audit functions are crucial in understanding and having assurance about the strong control culture and fair financial reporting processes.

Assuring Trustworthy Crypto Exchanges

Assuring Trustworthy Crypto Exchanges

Scope of External Audit

The scope of external audit is limited to the financial statements of the crypto exchanges or institutions which is under audit. External audit in most cases is the statutory requirement and the report of external auditors is shared with the shareholders of the organization or the company. 

External auditors are required to apply the audit procedures on the crypto transactions and the financial reporting compliances. External auditors’ scope is limited to the financial information and transactions that occurred during the financial year.

External Audit Essentials

External auditors perform an audit of the financial statements of the crypto exchanges or institutions and their scope is limited to the financial statements amounts and balances. It is essential for external auditors that they must be independent of the crypto exchanges or institutions which is audited. 

Independence means the external auditors must not be the employees of the company and should not take part in the decision-making process in any activity of the crypto exchanges or institutions. They perform an audit for the shareholders of the company, and must not obtain significant services from the crypto exchanges or institutions of which they perform the external audit. 

Should External Auditors Discover Fraud?

There may be the possibility that the management of the crypto exchanges or institutions prepares the financial statements fraudulently or try to artificially inflate or deflate the cryptocurrency financial disclosures, to show the wrong profits or financial position of the crypto exchange or institution to the shareholders. 

External auditors are required to obtain sufficient appropriate audit evidence to support the audit opinion on the financial statements of the crypto exchanges or institutions.

Reasonable Assurance

External auditors are required to provide their opinion on the financial statements of the crypto exchanges or institutions. They obtain evidence and corroborate the evidence to ensure that they may form a reasonable assurance that the financial statements of the crypto exchange or institution are prepared in all material respect as per the requirements of the applicable financial reporting framework.

As the management or Board of Directors of crypto exchanges or institutions may be involved in preparing the financial statements fraudulently, therefore, to cover the risk of non-detection of management fraud in preparing the financial statements, the external auditors appropriately plan the external audit. 

External auditors ensure that appropriate audit procedures are performed on the financial statements, balances, and amounts so that any intentional fraud is identified during the audit activities.

When the external auditors identify fraud in the financial statements of the crypto exchanges or institutions, then the matter is discussed by the external auditors with those charged with governance or the board of directors. The auditors ensure that the board takes appropriate measures, to rectify the identified frauds in the financial statements. After the rectification of fraud impacts, the external auditors reperform the audit procedures on the financial statements to ensure that fraudulent financial statements are rectified appropriately.

When the Board of Directors does not take the initiative to resolve the fraud issues in the financial statements, then the external auditors report such fraud facts to the relevant regulatory authorities of the organization and the institutions.

Internal Audit

Internal audit is an independent function within the organization or the company, which comprises a team of professionals who perform the audit of the internal controls and processes of the company or the organization.

The roles of internal audit are important in fraud identification and investigation; however, their scope is different from each other. Internal audit works as the third line of defense in the crypto exchanges or institutions, to check the operating effectiveness of internal controls and investigation of reported fraud incidents in different processes and departments. Internal audit is independent of the management and operations are likely to report a transparent position regarding the internal control system of the organization.

Assuring Trustworthy Crypto Exchanges

Internal Audit Essentials

Internal audit staff is the employees of the crypto exchange or institution and take salaries but they are not part of the management of the organization or the company. It means that they do not perform business activities or take part in performing the operations of the company. 

The internal audit department works as an independent department and reports to the Board Audit Committee (BAC). The internal audit department performs an audit of the processes and controls of various crypto transactions and functions. Audit observations are identified and reported by the internal auditors in the internal audit reports. 

Significant audit observations are reported by the head of the internal audit or the chief internal auditor (CIA) to the BAC periodically.

Should Internal Auditors Discover Fraud?

As the internal audit function performs an audit of the processes and checks the effectiveness of internal controls, therefore it is vested with the power to investigate fraud incidents related to the crypto exchange or transactions. Internal audit is provided with sufficient authority to obtain and review the relevant evidence both within and outside the crypto institution. Investigating fraud is the additional responsibility of the internal audit department in any crypto exchange or institution. 

Internal auditors appropriately plan fraud investigations and deploy relevant and experienced resources to investigate the case.  The process may involve interviewing fraudsters and other relevant employees. 

The investigation report is prepared by the internal auditors after performing the investigation procedures and gathering sufficient appropriate evidence. The fraud investigation report is shared with the Fraud Management Committee and with the BAC for their consideration and feedback.

Role of the Audit Committee in the Fight against Fraud

The Board of Directors forms sub-committees, to oversee different functions of the organization. To oversee the audit activities and effectiveness of the internal controls system of a crypto exchange or institution, Board Audit Committee (BAC) is formed. BAC works as a supervisory authority for the internal audit function of the crypto exchange or institution. The head of Internal Audit reports to BAC and works as secretary to the committee. All internal audit activities are completed under the supervision of the head of the internal audit. Significant audit issues and findings of each department are highlighted and a report is prepared for the BAC consideration.

Periodically BAC meeting is conducted, where the secretary to the committee presents significant internal controls breaches, violations, and fraud incidents. BAC reviews the findings and provides feedback for each control breach and violation. All significant types of violations and fraud are addressed according to the direction of BAC. BAC regularly monitors the implementation of feedback provided to the management and serious actions are taken against those who do not implement the BACs direction. 

BAC also ensures that measures need to be taken further, to enhance the internal controls system to avoid fraud, such as outsourcing arrangements where experts may be hired to review the internal controls system and provide the gap report to the BAC.  

BAC members ensure that the internal control system is enhanced and maintained to avoid fraud incidents. BAC helps in providing appropriate oversight, to build the transparent and robust controls, necessary to deter the occurrence of fraud.

Assuring Trustworthy Crypto Exchanges

Final Thoughts

In the rapidly evolving world of cryptocurrency, establishing robust financial controls and transparency is paramount. The essential role played by external and internal audits in assuring the reliability of internal systems, financial statements, and mitigating fraud cannot be overstated. They provide an invaluable check and balance, ensuring accurate financial reporting and bolstering shareholder trust. While external auditors impartially validate the accuracy of financial statements, internal auditors are instrumental in identifying and investigating operational vulnerabilities and fraud within the organization.

Furthermore, the involvement of the Board Audit Committee in overseeing the auditing activities underscores the depth of commitment to transparency and strong internal controls. In conclusion, navigating the complex crypto environment with confidence requires an intricate balance of these auditing processes to maintain transparency, integrity, and trustworthiness in every operation.