In September, Nexo unlocked an enormous achievement in granting our users the trust and transparency they deserve – we became the first crypto lender to pass a real-time audit of our reserves. This milestone is the product of months of intensive work and it would not have been possible if our auditors from Armanino – a top 25 accounting firm – hadn’t laid the technical foundation and built the necessary infrastructure for a blockchain audit. This is why inviting them to participate in our special-edition Ask-Me-Anything session was a no-brainer.
This month, the subject of the AMA is Nexo's real-time audit and the guests are none other than Armanino's Managing Director and Blockchain & Digital Assets Practice Leader Noah Buxton as well as Digital Assets Practice Manager Clayton Lowery.
Without further ado, here are the answers to the top questions summarized in this blog post. You can also watch the whole AMA here:
What does the audit give us? What opportunities does it open up? What is the next step?
Antoni: The real-time reserves audit is the latest big Nexo transparency achievement and an interim step en route to fuller audits. Nexo is among the very few companies that modeled their businesses on serious financial institutions back in 2018 and has always been very mindful of regulation. The independent attestation, which shows that Nexo’s assets exceed liabilities at all times, increases the level of transparency in the space, sets the bar higher for other players, and challenges other companies to follow Nexo’s lead to the benefit of the overall community and institutions looking to enter the cryptocurrency space.
Nexo.io and Ledn, both crypto lenders, claim that they were the first to be real-time audited by Armanino. One of them must be wrong, who is it?
Noah: Both claims are true but there are some complexities and it requires a little bit of explanation, think of how you explain crypto to your friends and family. Nexo’s procedure marks the first time that a lending platform has gone real-time in providing this level of transparency. This is really significant because of the assurance process required to prove reserves in real-time: that entails a very high transaction volume and requires a Herculean lift – deep integration with the client as well as a 100% asset and 100% liabilities coverage.
Can you explain in layman terms what the assets and liabilities for Nexo are? I read the report but my financial terminology was not sufficient.
Clayton: On the assets’ side, it’s primarily three things: digital assets, fiat currency, and Nexo’s loan book. It is specifically assets that Nexo holds that reserve client liabilities and does not include things like fixed assets. Armanino went on the blockchain into Nexo’s various exchange accounts and queried the nodes and exchange APIs to accumulate all digital assets that are on Nexo’s platform. As for fiat, it was a similar yet much more difficult process with the old-school banking data at traditional banks. Then the loan book constitutes the loans provided by Nexo to their customers and they sit as assets on the balance sheet of a lending company. When you top up an asset into Nexo’s platform, on their side they create a liability that they owe back to you.
Noah: Think about the traditional banking analogy. 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. That has led to this spirit in the industry that expects players that we trust with our keys to be adequately reserving assets. Looking at the big picture, it’s the run on the bank – I don't think this would happen, but if every Nexo customer decided to take their crypto and put it in cold storage, Nexo could allow that for every single one.
Since Nexo is the first-ever crypto lender to be audited, would you please share more about the differences and challenges you faced while auditing them?
Noah: Any company that is trying to do the right thing, still has to prepare for an audit. There’s a level of dedication that’s required – they have to put time, people, and resources into producing auditable information.
There are two big buckets of challenges: on the liability side lies a technical challenge – how do we get a complete and accurate snapshot of customer liabilities at a point in time? Nexo has great systems and this is not a challenge that is limited to them.
On the asset side, usually, auditors use a sampling methodology to determine which assets they need to test. What’s different in real-time attest is that we don’t have the luxury of sampling – we integrate with every single cold-storage wallet, every counterpart, every exchange – and that’s much more work. The Nexo team put a lot of effort into it but it’s typically not an easy process.
Does the audit attest that Nexo isn't unsustainably borrowing money to pay interest, or are such potential liabilities (ie junk bonds) not included?
Clayton: We see the whole picture: if there is anything unsustainable, it's gonna show up on our platform. And that's why I think Nexo is taking an awesome lead to do this because they know if they do [something unsustainable], we would know about it, and thus you would as well.
Sir, what makes Armanino a suitable company to audit crypto projects? What made you take that step as opposed to traditional financial audits?
Noah: Armanino started financial statement audit and other attest work with crypto companies in 2014, at a time when even the Big Four were very hesitant to get in. We’ve served the household names in crypto for years now, so this is not just a small offshoot – it’s a strategic focus for the firm and that means we have dedicated people that spend 100% of their time doing crypto. The capability to be able to get access to blockchain data and to do test ownership with digital asset signatures on multiple chains requires time and experience and our dedicated teams – which are really deep into crypto – make us a really suitable company to audit crypto projects.
How can I be sure that my client data (portfolio, address, names, etc.) has been (and still is) kept confidential during the audit process?
Clayton: On the Trust Explorer side, we don’t ingest any Nexo client data at all. We’re not looking at or storing addresses or any KYC-type of client information.
Now that the audit is here, will this change regulators' view of Nexo and more specifically the token's security status & earn on crypto in the US?
Antoni: Any sort of third-party attestation is good for proving the credibility of any entity but I don’t think there’s a huge amount of bearing with regards to regulators’ view on what’s a security and what’s not. What matters is how we, as crypto lending businesses, react collectively. At Nexo, we always talk with legal advisers just to guarantee sustainability for the business in the long term and will continue to push for everyone’s right to earn a yield well above the inflation rate.