Proof of State: A Comprehensive Analysis of Auditchain

Proof of State is one term that has recently garnered attention, especially following some significant crypto failures in 2022. However, to understand Proof of State and its significance, it is imperative to understand the basics of accounting and financial reporting.

Accounting: The Language of Business

Accounting is an integral part of the business world, serving as a way for entities to communicate financial information to their stakeholders. This information is then reported to the public through financial statements, allowing a clear understanding of a company's financial health and operations.

One critical aspect of financial reporting is the audit. An audit is a comprehensive examination of an entity's financial statements and records conducted by an independent auditor. The purpose of an audit is to assure stakeholders and the public that the financial statements are accurate and free of material misstatements.

Lately, the growth of the cryptocurrency market has led to an increased demand for auditing services in the crypto industry. In addition, cryptocurrency and blockchain technology have created new opportunities and challenges in finance, and the public must clearly understand these concepts to make informed investment decisions.

The lack of standardization and regulations in the crypto market has made auditing a crucial component in building trust and transparency in the industry. Through auditing, stakeholders can better understand the cryptocurrency business's financial health and operations, allowing them to make informed decisions.

Proof of Reserves Controversy

The crypto space is known for its confusing terminology, and Proof of Reserves was one such term that caused a lot of confusion among the public. In the end, this misunderstanding of Proof of Reserves was one of the key reasons the audit profession pulled back from the crypto space. However, the positive side of this controversy is that the public has now gained a more profound understanding of the different types of engagements performed by professional services firms.

Proof-of-reserve audit firms, such as Mazars Group and Armanino, have discontinued their services to cryptocurrency companies. With these departures, the industry is left searching for auditors to fill the void. Unfortunately, the “Big Four” accounting firms – Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers – are reportedly “unwilling” to take on these services for private cryptocurrency companies. This raises questions about the future of proof-of-reserve audits in the crypto industry.

The Importance of Proof-of-Reserve Audits Proof-of-reserve audits crucial in determining a cryptocurrency entity's financial condition. They provide validation that exchange assets are equal to or greater than the exchange's liabilities to its customers. This information is essential for investors to make informed decisions, as it gives them an accurate view of the financial state of the entity.

The departure of Mazars Group and Armanino Mazars Group provided proof-of-reserve audits for KuCoin, Binance, and Crypto.com. Still, it stopped offering these services due to “concerns regarding how the public understands these reports.” On the other hand, Armanino, the auditing firm for companies like FTX US and Kraken, is also said to be exiting the crypto space.

The “Big Four” Accounting Firms' Stance Despite the need for proof-of-reserve audits in the crypto industry, the “Big Four” accounting firms are reportedly “unwilling” to conduct these audits for private crypto companies. While Deloitte currently works with Coinbase and Ernst & Young recently revealed a partnership with TaxBit, none of the firms have stepped up to fill the gap left by Mazars Group and Armanino.

The Future of Proof-of-Reserve Audits With the departures of Mazars Group and Armanino and the “Big Four” accounting firms unwilling to fill the void, it is unclear who will step up to provide proof-of-reserve audits in the crypto industry.

PoR Alternative: Agreed Upon Procedures (AUP) Engagement

An AUP engagement is a type of audit or assurance service performed by a public accounting firm, where the scope of work is agreed upon between the auditor and the client. The purpose of an AUP engagement is to allow the auditor to perform specified procedures on the selected subject and report on the findings to the intended users. The report produced after the engagement is a powerful tool for ensuring the safety and reliability of crypto investments.

In the crypto industry, AUP engagements are becoming increasingly popular in assuring various aspects of a crypto business or organization. For example, an AUP engagement can be used to verify the accuracy of cryptocurrency holdings, the completeness of transaction data, and the compliance of a crypto platform with relevant regulations. By having an independent, third-party auditor perform the agreed-upon procedures, stakeholders can have confidence in the accuracy of the information provided.

During an AUP engagement in the crypto industry, the auditor and the client will agree on the specific procedures to be performed. For example, these procedures may include a review of the platform's security measures, a reconciliation of wallet balances, and a review of transaction data. The auditor will then perform the agreed-upon procedures and report the results to the intended users, such as investors, regulators, and stakeholders.

AUP engagements in the crypto industry offer assurance to stakeholders, helping to build trust in the platform and increasing transparency in the market. By having an independent, third-party auditor perform the agreed-upon procedures, stakeholders can have confidence in the accuracy of the information provided. This helps to reduce the risk of fraud, hacking, and other security threats that can harm investors and undermine the stability of the crypto market. However, the report produced after the engagement boldly states: “You should not rely on this report.” This statement is meant to be taken seriously, and it is hoped that the crypto failures of 2022 and the lack of controls in the financial system of FTX will serve as a reminder to the public to always exercise caution and due diligence when it comes to their investments.

In Comes Auditchain with Proof of State

Auditchain is a decentralized infrastructure that aims to automate and provide proof of assurance for financial and business information in the world. The project's goal is to create a new alternative for stakeholders to access external validation, incentivize the institution of accountancy to contribute to the infrastructure, and move regulatory disclosure frameworks towards real-time reporting and continuous verification for digital asset issuers and open ledger-based investments.

The main objectives of the Auditchain Protocol are as follows:

1. To provide an alternative source of external assurance to stakeholders of centralized crypto market infrastructure providers and exchanges.
2. To motivate and incentivize the accountancy industry to contribute to the infrastructure.
3. To move global regulatory disclosure frameworks from periodic information embargoes to real-time reporting and continuous assurance suitable for digital asset issuers and open ledger-based investment society.

Balance Sheet: A Measure of State

The term “State” in Proof of State refers to the attributes of a balance sheet. A balance sheet is a critical document that provides a snapshot of the financial position of an entity at a specific moment. It is a crucial component of accounting and is used to measure the “State” of an organization. The balance sheet is derived from the accounting equation “Assets = Liabilities + Owner's Equity" and gives a clear picture of the entity's assets, liabilities, and net worth.

A balance sheet is an essential tool for stakeholders, including investors, lenders, and regulators, as it provides information about the entity's financial stability and ability to meet its obligations.

To ensure the accuracy and reliability of the information reported in a balance sheet, it is essential to have appropriate internal controls. These controls may include policies and procedures to maintain the accuracy of financial records, regular independent audits, and the use of technology to track financial transactions and monitor financial data.

Profit and Loss Statement and Cash Flow Statement

A comprehensive analysis of a company's financial health requires a look at its balance sheet and thoroughly examining its Profit and Loss (P&L) statement and Cash Flow statement. The P&L statement is essential for understanding a company's performance over a specified period, typically a quarter or year. It provides an overview of the company's revenue, expenses, and profit margins, providing valuable insights into its operations and financial position. On the other hand, the Cash Flow statement provides a snapshot of a company's inflow and outflow of cash over a specified period, giving investors and stakeholders an understanding of the company's liquidity and ability to pay its bills.

These two statements work hand in hand with the balance sheet to provide a complete picture of a company's financial health. The P&L statement shows the company's profitability, while the Cash Flow statement highlights its ability to generate and manage cash. Together, they paint a picture of the company's financial strength, allowing investors and stakeholders to make informed decisions. In conclusion, understanding the Profit and Loss statement, Cash Flow Statement, and Balance sheet is vital for comprehensively evaluating a company's financial condition or “State.”

The Importance of Knowing the State of an Entity

Understanding the State of an entity goes beyond just the numbers presented in the financial statements. It requires a more profound understanding of the entity's operations, competitive landscape, and future prospects. This information, combined with the financial statements, can provide a complete picture of the entity's financial condition and enable investors to make better investment decisions. Additionally, investors must be aware of the limitations of financial statements, including their historical nature and the assumptions and estimates that underlie the numbers presented.

Given the complex and constantly evolving financial world, investors must also be vigilant and stay informed about changes in accounting standards and regulations that could impact the financial statements of entities they are interested in investing. It is also essential to understand the different types of financial statements and how they are prepared, such as the balance sheet, profit and loss statement, cash flow statement, and statement of changes in equity.

Subsequently, investors must have access to accurate and up-to-date financial information and have a more in-depth understanding of the entity's operations, competitive landscape, and future prospects. It is also essential to stay informed about changes in accounting standards and regulations and understand financial statement limitations.

Auditchain's Concept of Royalties and Process Control NFTs

The project proposes “perfecting” the allocation of royalties between creators and validators of accounting, reporting, audit, and analysis controls. In addition, the network will become more automated as it populates with more controls. This forms the basis of a wholly automated virtual machine for accounting, audit, financial reporting, and analysis.

The virtual machine is designed to provide a safe and efficient platform for crypto market infrastructure users and accountants. Accountants can earn AUDT tokens every time their controls are used, and validators who audit the controls also earn AUDT tokens. Anyone who can create a Process Control NFT must understand accounting, reporting, audit, or analysis logic.

The Importance of a Virtual Machine

A virtual machine is necessary for defining the rules for computing a new valid financial state. The Auditchain Protocol is a layer two protocol that uses its client, Pacioli, to define and validate proof of financial state. Each economic entity is unique, and its data and logic sets are diverse and complex, requiring constraints to compute and validate its financial state.

Machine readability is critical for bidirectional data and logic interchange, and is reinforced by cryptography. The EU requires both machine-readable and human-readable data and logic, and it is expected that machine-readable data and logic will soon be within audit scope in other parts of the world. Auditors rely on the financial reporting controls of an economic entity to gain confidence in its data, making it essential to audit these controls.

Validation of Process Control NFTs

The NFTs are issued to curators following the validation of each control by multiple auditors under ISAE 3402 standards. As accountants and professionals earn more AUDT by contributing more Process Control NFTs to the library, financial state articulation becomes more precise and reliable, allowing for better predictions and estimations of future outcomes.

Building a Portfolio of Process Control NFTs

Building a portfolio of Process Control NFTs (Non-Fungible Tokens) is a new and innovative way of investing in the future of finance and accounting. NFTs are unique digital assets stored on a blockchain, making them tamper-proof and verifiable. The use of NFTs in process control refers to using tokens to verify and control various processes, such as financial reporting or auditing.

Process Control NFTs provide a new level of transparency and security in the financial industry. They allow for real-time monitoring of processes and the ability to verify the authenticity of the reported information. These tokens also provide a new level of trust between parties, as they provide evidence of the completion of a process and can be verified by anyone on the network.

In addition, owning Process Control NFTs can provide a new revenue stream for accountants, professionals, and enterprises. The tokens can be sold in the future, providing a return on investment for the owner. This new investment method offers a unique opportunity to participate in the future of finance and accounting while also providing a secure and valuable asset that can be used in the future.

Building a portfolio of Process Control NFTs is a smart and forward-thinking investment strategy that can benefit professionals and enterprises alike. The use of NFTs in process control is a growing trend. By investing in these tokens, individuals and organizations can be at the forefront of this development and reap the benefits in the future.

In Summary and Conclusion

Cryptocurrency and blockchain technology has disrupted the traditional financial world and created a new landscape for accounting and financial reporting. With the growth of the crypto market, there has been an increased demand for auditing services in the industry. Proof of Reserves (PoR) audits are crucial in determining the financial health of a cryptocurrency entity, as they assure that exchange assets are equal to or greater than the exchange's liabilities to its customers.

However, the crypto space is known for its confusing terminology, and PoR was one term that confused the public. The misunderstanding of PoR was one of the reasons why the audit profession pulled back from the crypto space, leading to the departure of proof-of-reserve audit firms such as Mazars Group and Armanino. Furthermore, despite the need for PoR audits, the “Big Four” accounting firms – Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers – are reportedly “unwilling” to take on these services for private cryptocurrency companies, leaving the industry searching for auditors to fill the void.

An alternative to PoR audits Agreed Upon Procedures (AUP) Engagement, which is becoming increasingly popular in the crypto industry. An AUP engagement is an audit or assurance service where the scope of work is agreed upon between the auditor and the client. An AUP engagement aims to assure various aspects of a crypto business or organization, such as verifying the accuracy of cryptocurrency holdings, the completeness of transaction data, and compliance with relevant regulations.

Proof-of-reserve audits and AUP engagements are crucial in building trust and transparency in the crypto industry. The departure of proof-of-reserve audit firms and the “Big Four” accounting firms' stance on not taking on these services for private crypto companies raises questions about the future of auditing in the crypto space. However, with the growing demand for auditing services in the industry, it was only a matter of time before new players emerged to fill the gap and provide the necessary assurance to stakeholders and the public.

To fill the void; Auditchain is ready to step up. Their protocol has the potential to revolutionize the way financial information is disclosed, verified, and analyzed, providing a more transparent, secure, and efficient system for businesses and financial organizations around the world.

The benefits of the Auditchain Protocol are numerous and far-reaching, including:

1. Improved transparency and reliability in financial reporting, reducing the risk of fraud and errors and increasing the overall quality of financial information.
2. Increased efficiency and cost savings, as the automation of financial disclosure, reduces the need for manual processes and eliminates the risk of errors.
3. Better compliance with regulatory requirements, reducing the risk of costly fines and reputational damage.
4. Enhanced trust and credibility with stakeholders, including investors, regulators, and the public.
5. A more secure and tamper-proof system for storing and accessing financial information, reducing the risk of cyber-attacks and data breaches.

Auditchain Labs AG is leading the way in developing a decentralized accounting, audit, financial reporting, and analysis protocol that has the potential to revolutionize the way financial information is disclosed, verified and analyzed.

With its numerous benefits, the Auditchain Protocol is poised to play a critical role in the future of financial reporting and analysis.