Blockchain Auditing – Accelerating the Need for Automated Audits

Read full EDPACS "Blockchain Auditing" article

Written by Lukka Audit Advisors Michael P. Cangemi and Gerard (Rod) Brennan.

Limitations of Auditing Blockchains (a snippet from the full article above)

Blockchains are not a panacea and will not cure all that ails accounting and auditing. There are clear limitations as to where and how blockchains can contribute to the next generation of commerce and accounting practice. For the foreseeable future, it is doubtful a BC/DL will ever be used for the primary general ledger of large entities. Most BC/DL on the horizon will be for supplemental or supporting shared sub-ledgers within or among cooperating individuals or organizations.

Another key limitation of leveraging BC/DL networks is that block- chain networks often have incomplete or a limited amount of data needed to perform an audit of a complete process of end-to-end transactions. Blockchains by design carry a limited amount of infor- mation in the database in order to ensure privacy and prevent the network from “bloating” (getting too large to efficiently be sent out to all nodes on the blockchain) as the network grows. Remember, block- chains are generally not archived and must keep and distribute all of the information on the chain from the first or “genesis” block to the current block. A blockchain record may only have a few fields such as a public key, a number of units, a date stamp, etc., lacking any valuation, link to source documents, and other critical information needed to evaluate internal controls and perform a comprehensive audit, therefore new audit approaches are required.

Blockchain networks transacting with cryptocurrencies on public blockchains have a unique limitation in evaluating or auditing transactions because the blockchain often provides an incomplete picture of the transactions related to an individual or entity. This results from cryptocurrency Exchanges and Wallets centrally clearing and settling transactions (i.e., trades) at the exchange such that some intraexchange transactions are never submitted to the blockchain. As an example, if cryptocurrency trader “A” on exchange “X” transfers 5 Bitcoin to cryptocur- rency trader “B” also on exchange “X”, this transaction may never be submitted to the Bitcoin blockchain because exchange “X” will just clear/settle the trades between the two clients. This common trading practice results in many “off-chain” transac- tions allowing cryptocurrency exchanges to save  time,  effort and money by not submitting intra-exchange trades to the block- chain. In Over The Counter Trading (OTC) of cryptocurrencies and with most deposits and withdrawals on exchanges the transactions are bilaterally cleared with each counterparty and settled on the blockchain – these are referred to as “on-chain” transactions.

Therefore, the Vast Majority of Economic Transactions with Crypto Assets Today are Not Transacted on the Blockchain!