Proof of Reserves has become the latest fad amongst centralized exchanges (CEX) wishing to distance themselves from the under-collateralized, overly confident SBF/FTX debacle. The charge has been led by Binance CEO Changpeng “CZ” Zhao who called for crypto exchanges to adopt Merkle-tree proof-of-reserves to provide users the confidence they need to interact with centralized exchanges. But what does it all mean? Are proof-of-reserves enough? Is it the whole picture?
Binance Takes the First Step
Binance released a post on their blog titled “Our Commitment To Transparency” the same day they decided to not pursue the FTX acquisition deal. The post provided details of Binance’s hot and cold wallet addresses and covered major tokens on BTC, ETH, BSC, BNB, and TRX networks. It is important to note that this post is a starting point while the Binance team develops a fully audited report, to be released in the coming weeks.
The portfolio reveals over $64B in assets with a majority of them being held in stablecoins such as BUSD and USDT. The majority of the tokens held are held on the Ethereum network (63%) with Tron (19%) and Bitcoin (12%) taking second and third place.
Other Centralized Exchanges Follow
Nansen is a blockchain analytics platform that has graciously aggregated the revealed wallet addresses of every CEX that has come out with a statement regarding their proof-of-reserves. Users can easily view the token allocations of the firm as well as the balances of each asset. This thread contains the disclosed exchange holdings and associated explanatory statements for Binance, Crypto.com, OKX, KuCoin, Deribit, Bitfinex, and Huobi.
More than Proof-of-Reserves
The key criticism of this increased transparency from Binance and other CEXs is that none of them have yet to provide an adequate list of liabilities. As we have learned from the FTX scandal, it is possible for a firm’s liabilities to clearly outweigh its assets. It’s actually more than likely that your local bank is over-leveraged. This is not an inherently bad feature of a CEX/bank but clear communication and reporting are required to accurately assess the risk involved. Showing assets without context fails to prove anything besides one piece of the puzzle.
CEXs may also claim that they’ve been audited and hope that that provides comfort to their users but accountants are still more than capable of ‘creative accounting’ or the odd ‘mislabeled wallet’. Just ask SBF or the now-defunct accounting firm Arthur Andersen behind the $11 billion dollar collapse of Enron.
An Open Call
Binance recently published an article titled ‘Six Commitments for Healthy Centralized Exchanges’ wherein CZ discussed six of the most important requirements that Binance and every other centralized exchange needs to adopt to ensure trust within the community.
The Six Commitments for a Healthy Centralized Exchange are as follows:
- Be risk-averse with user funds
- Never use native tokens as collateral
- Share live proof of assets
- Keep strong reserves
- Avoid excessive leverage
- Strengthen and Enforce Security Protocols
The article outlined the importance of never trading or investing user funds as well as being extremely cautious with leveraged trading. CZ implored industry partners to adopt a more fiscally conservative approach and reminded readers that Binance’s capital structure is debt free. Binance recently topped up their Secure Asset Fund for Users (SAFU) emergency insurance fund to $1 billion dollars. CZ also committed to providing a Merkle-tree proof of funds that will be shared with the community in the coming weeks.
Closing Thoughts
CZ and Binance are saying all the right things but the crypto community has some prevailing trust issues that won’t be going away anytime soon. As the world’s largest centralized exchange, Binance needs to be the trendsetter the crypto industry needs to start to heal the wounds left from Terra/LUNA, 3AC, Celsius, and now SBF.
