Nexo’s Real-Time Public Audit Sets High Transparency Standard

As recent events have shown, a crypto platform’s financial health is the most important variable for any investor looking for somewhere to place their assets, but the true state of most platforms’ finances is opaque at best.

In such an environment, the decision last year by Nexo to engage top 25 accountancy firm Armanino LLP to deliver an ongoing real-time audit of Nexo’s assets and liabilities was an industry game-changer.

What is Nexo’s real-time audit? 

The audit is housed and delivered via an Armanino project called TrustExplorer which the company describes as “the world’s first application that provides independent accountant reports in real-time.” Using the TrustExplorer Real-Time Assurance Platform, anybody can download a six page report (which is up-to-the-minute accurate). 

The report details Nexo’s current liabilities, along with an independent attestation by the accountancy firm that Nexo’s assets are greater than its customer liabilities. If you were to download the report again the following day, the customer liabilities would be different and the attestation would be updated accordingly.

What’s the technology behind TrustExplorer?

To produce the report in real-time Armanino has access via API into Nexo’s exchange accounts and wallets, and queries the nodes and exchange APIs to account for all digital assets that are on Nexo’s platform. In terms of painting a ‘complete’ picture this is a somewhat novel approach as auditors will typically use a sampling methodology to determine which assets they need to test. However, blockchain technology enabled Armanino to go further than this. 

Instead, the firm was able to integrate with every cold-storage wallet, every counterpart, and every exchange – thus gaining thorough insight into Nexo’s digital assets, fiat currency reserves, and the company’s loan book. 

Crypto platforms should not be operating fractional reserves

Nexo and other major players like the now failed Celsius and teetering BlockFi have attempted to take on traditional banking. But it’s fair to say that the public perception of the legacy banking sector tilts the deck against the crypto platforms for a reason that’s not immediately obvious.

The fact is that the public has been conditioned to trust the banking sector even though if there was ever a run on the banks their customers would soon discover that all banks operate a fractional reserve system. This means they lend out a lot more money than their assets on hand would cover should all depositors want to withdraw their money at once. 

In the US and many other countries government bank deposit guarantees add to that complacency, but many people don’t realise that if they invest for their retirement in a mutual fund or annuities offered by their bank, those deposits are not FDIC insured. Nonetheless, the overall perception is that any money invested into bank financial products is basically risk free.

But as Armanino’s managing director Noah Buxton observes, no such public goodwill exists towards crypto finance companies. “When you deposit a dollar at the bank,  that dollar is really not 100% reserved, there’s some fractional reserve banking that happens. In crypto, from an ethos perspective, the community has not accepted that and this is because of the nature of digital assets – they’re much more like a gold bar than fiat currencies that can be reprinted.

Buxton says given the community views crypto assets in this way, they also expect the entire loan book to be covered by assets on hand, with no fractional lending. Events have shown this clearly isn’t the case. However, in late 2021 Buxton said that the Armanino audit shows that in the unlikely event of all Nexo’s depositors wanting to withdraw their assets at once, “Nexo could allow that for every single one.” 

Although more regulation for crypto assets is coming down the pipeline, today the sector remains generally unregulated and highly volatile. In such an environment, an independent real-time attestation by a credible accountancy firm which shows a platform’s assets exceed its liabilities at all times, is nothing less than a game changer. 

Proof-of-reserves audits like this at Nexo, and a similar one completed by Ledn, increases the level of transparency in the sector — benefiting the overall community and setting the bar higher for other players to follow their lead. As depositors flee the space, it’s likley many other platforms will be forced to deploy similar audits to have any chance of convincing lenders to return.

Article originally published at Mooloo.net