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EY ShinNihon LLC is a member firm of EY (Ernst & Young), which has approximately 400,000 employees in over 150 countries and regions around the world and provides audit and assurance, tax, strategy and transaction, and consulting services.
We asked Keiji Tanaka of the firm, which provides leading expertise and services in the Web 3.0 industry, about the main challenges of accounting audits in cryptocurrency and blockchain businesses.
Please tell us how you came to be co-leader of the BlockChain Center at EY ShinNihon LLC.
Keiji Tanaka (hereinafter, Tanaka): I started my career as an accountant in 2000, and first came into contact with the field of crypto assets around 2017.
Initially, I was auditing major consumer goods companies such as food and cosmetics, but by chance, several clients I was in charge of at the time started to develop businesses related to crypto assets and Web 3.0, so I became involved in that field as well.
In 2017, the term "Web 3.0" itself was not yet common. As I faced various problems related to crypto assets through my audit work and deepened my knowledge, I was able to increase my knowledge of the field within the firm, and thankfully I became recognized as a knowledgeable person within the firm.
Gradually, the number of consultations regarding crypto assets increased, and now I have several crypto asset exchanges as clients.
In this way, I began to receive more crypto asset cases, which led to my position as co-leader of the BlockChain Center at EY ShinNihon LLC.
Were you scared of cryptocurrencies?
Tanaka: In audit work, stock investments are heavily regulated due to considerations of independence and insider trading regulations, but there are also certain restrictions on cryptocurrency investments.
I myself have owned cryptocurrencies, including Bitcoin, but since I didn't own that much, I didn't feel particularly scared of cryptocurrencies.
What are the current main challenges for accounting audits in cryptocurrency and blockchain businesses?
Tanaka: In March 2022, the Liberal Democratic Party's Web 3.0 project team released a Web 3.0-related white paper, pointing out 24 issues.
Among them was the difficulty of accepting accounting audits for Web 3.0 companies. To address this issue, the Japanese Institute of Certified Public Accountants has cooperated with JCBA and others to start joint forums and study sessions. This is an effort for accountants and businesses to deepen their understanding together and discuss various issues.
I think there have been many misunderstandings about Web 3.0 in particular in the past two years. For example, there were questions about whether holding Ethereum would affect listing. However, accounting standards for the ownership of crypto assets exist, and appropriate accounting and auditing responses are possible.
On the other hand, with regard to corporate entities that issue crypto assets, there are various issues such as accounting standards being under development, legal arrangements not being clear, and tax issues, and it is true that auditing is also a high hurdle. As an industry group, we are working while distinguishing between areas that can be audited and areas that require further discussion.
I feel that there are many challenges when various transactions occur within an ecosystem, such as blockchain games, right?
Tanaka: In Japan, cryptocurrency exchanges are required to undergo accounting audits. Exchanges are mainly divided into two business models: sales offices and exchanges, and are operated under strict monitoring by the Financial Services Agency, and accounting audit obligations have been introduced as part of these regulations.
In fact, since the large-scale domestic cryptocurrency leak that occurred in 2018, no major problems have been reported, thanks to the results of these regulations. On the other hand, there are a wide variety of Web 3.0-related businesses, such as cryptocurrency issuance and blockchain games, but it is true that accounting audits are not keeping up with them.
Rules for issuing cryptocurrencies, such as IEOs, are being established, but it is not necessarily the case that audit firms are able to accept audits smoothly. In the future, as accounting standards are developed and legal characteristics are clarified, and the need for investor protection increases, I believe that audit practice will increase in this area in the future.
In addition, there are an increasing number of cases of listed companies developing and operating blockchain games, and with regard to the incorporation of DAOs, which is currently being discussed, issues are likely to arise in the future, such as the need for assurances through third-party audits, similar to those required for audits of corporations.
What accounting and auditing standards exist for cryptocurrency-related businesses?
Tanaka: With the mandatory accounting audits of cryptocurrency exchanges, accounting standards that should be applied to cryptocurrency holders and practical guidelines for accounting audits of exchanges have been established. Security tokens and stable coins have also been legislated in Japan, and accounting standards that should be applied to each of them have been established in light of this.
However, because there are many different types of blockchain-related businesses, there are currently no accounting standards or audit practical guidelines that can cover all business forms.
How do you evaluate the value fluctuations and security risks of cryptocurrencies and incorporate them into your audit process?
Tanaka: For example, if a company records tokens issued by other companies as assets on its balance sheet, an accounting audit will verify whether the tokens owned by the company actually exist in the wallet and whether their prices are appropriately valued.
There are fewer issues with well-known tokens, but if a company holds a large number of unknown tokens, particularly careful judgment is required in determining their existence and value.
In addition, the specifications of the blockchain on which the tokens held by the company exist and the risk of the company's blockchain wallet being suddenly hacked must be taken into consideration.
For this reason, the reliability of the blockchain and the company's private key management system will also be subject to audits.
Bitcoin and Ethereum have high trading volumes and active markets, making it easy to value them, but unknown tokens with low trading volumes pose challenges in terms of appropriate market valuation.
Would it be difficult to make a decision if people in the community colluded to hold onto the token to prevent the price from falling?
Tanaka: That's right. From the perspective of market value, if the circulation in the market is low, even if the price appears high, it doesn't necessarily mean that trading will actually take place at that price.
Under Japanese accounting standards, whether or not a cryptocurrency is valued at market value depends on whether or not there is an active market for it, so the trading situation in the token market is also a major point of consideration in accounting audits.
What is your view on the impact that expected legal changes (IEOs, leverage, etc.) will have on cryptocurrency and blockchain-related audits?
Tanaka: Web 3.0 businesses have unique business risks that are different from other businesses, such as the risk of unauthorized access leading to the leakage of cryptocurrencies managed in a company's wallet.
In addition, there are still many areas where the legal status is not yet established, and there may be cases where the business operators themselves overlook some major risks.
As an auditor, it is naturally important to consider how accounting procedures are carried out, but I think it is also important for us as auditors to understand what the unique business risks are each time a new Web 3.0 business is born.
Just like in the field of Web 3.0, international standards will likely be established for auditing in this field in the future. What are your thoughts on this?
Tanaka: I understand that the audit methods and standards for blockchain and crypto assets are global and to a certain extent unified.
We at EY are a global organization and are always working with overseas teams. For example, we exchange information on whether there are any cases overseas where tokens have been handled.
On the other hand, while there are accounting standards that are common worldwide, called International Financial Reporting Standards (IFRS), there are also accounting standards unique to Japan (JGAAP), and the handling of each accounting standard varies.
I understand that accounting standards and audit methods will continue to be considered and developed in the future to accommodate Web 3.0 businesses, which are constantly evolving in new forms.
What are some accounting points that cryptocurrency-related businesses should be careful of?
Tanaka: There are many types of tokens, and in Japan, in addition to crypto assets under the Payment Services Act, such as Bitcoin, there are legal frameworks for security tokens and stable coins. The accounting standards for these have also been clarified to some extent.
On the other hand, there are tokens such as NFTs that are not categorized under any legal framework in Japan. There are also contract forms whose legal status is not clear, such as SAFTs, which are rights money to acquire tokens in the future.
In accounting audits, discussions begin with how to handle cases whose legal status is unclear in accounting terms, and it can take time to respond. We, as auditors, believe it is important to deeply understand the actual situation of Web 3.0 businesses through dialogue and exchange of opinions.
Keiji Tanaka
He started his career as an accountant in 2000, auditing major consumer goods companies such as food and cosmetics, and then provided audit and assurance services to various companies related to crypto assets and blockchain. Currently, he is co-leader of the BlockChain Center at EY ShinNihon LLC, where he performs audit and assurance services, leads human resource development and consultation in this field within the firm, and is also involved in accounting audits for major companies across multiple sectors such as consumer goods/retail, technology, and media/entertainment.
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