Since FTX, the cryptocurrency industry has been desperate for proof that the last prominent exchange standing, Binance, is solvent. Binance’s CEO, CZ, promised us an audit that would prove without a doubt that they are well collateralized. Well, Binance’s audit is here, and it’s hardly the security blanket we all needed this winter.
Feel free to check it out yourself, it isn’t very long, but it is full of jargon.
How this audit works
Binance contracted an audit firm Mazars to build this report. Basically, Binance asked them to perform a specific assessment of their holdings called an “Agreed-Upon Procedure” or AUP. This specifies the type of data Binance will be providing and the scope of the audit, and what Mazars is to look for.
It’s like telling your mechanic you want your brakes checked. But unlike your mechanic, an audit firm will not check things outside the scope of the AUP. Furthermore, they will not even tell you if the AUP you have agreed to is appropriate for what you are trying to do.
An AUP engagement involves us performing the procedures that have been agreed with Binance, and reporting the findings, which are the factual results of the AUP performed. We make no representation regarding the
Paragraph 4, BINANCE CAPITAL MANAGEMENT CO. LTD. (“BINANCE”) – PROOF OF RESERVE (“POR”) REPORT
appropriateness of the AUP.
Returning to the mechanic analogy, say your brakes are squealing, and you tell your mechanic you think it’s a problem with your brake light. If your mechanic operates like an audit firm, he’ll check your brake light and send you on your way with squealing brakes.
In a way, this is what Binance did. Binance’s audit report clearly states in the opening paragraph the following:
Our report is solely for the purposes of offering Binance’s customers and prospective customers additional transparency and reassurance that their In-Scope Assets are collateralized, exist on the blockchain(s) and are under the control of Binance at the below mentioned reporting date. For the purpose of this Agreed-Upon Procedures (“AUP”) engagement the term “collateralized” will be defined as where Binance’s In-Scope Assets are equal to or greater than the net liability of In-Scope Assets as per the Customer Liability Report owed to and receivable from customers.
For the purpose of this engagement the customers’ spot, options, margin, futures, funding, loan andearn accounts for bitcoin (“BTC”) and wrapped bitcoin (“BBTC” and “BTCB”) held on the Bitcoin, Ethereum, BNB Chain and Binance Smart Chain blockchains will be defined as the In-Scope Assets.
In plain English, the audit firm is confirming that they are only checking three things:
- Does Binance have enough BTC and wrapped BTC to cover customer BTC deposits?
- Does the BTC Binance claims to have exist on the blockchain?
- Does Binance have control of the addresses that hold this BTC?
Before we get into the issues with the scope of this audit, let’s address these questions. For questions 2 and 3, the answer is a simple yes! Hooray!
Question 1 is a bit more complicated. If you only count customer deposits as liabilities, then Binance is over-collateralized at 101%. However, if you include loans Binance has made to customers borrowing BTC, they are only capitalized at 97%. This isn’t too bad, assuming those loans were made to customers who deposited collateral that was out of the scope of this audit. Theoretically, if there was a massive BTC run on Binance, they could sell the collateral for more BTC.
If you’re feeling giddy, hold your horses. This was just a BTC audit, and the data used to conduct the analysis was provided by Binance. What about all of their hundreds of other assets in custody? How can we trust their accounting practices? They’ve been completely unexamined.
Many professionals are scoffing at the idea of even calling this an audit.
Does all this mean that Binance is the next FTX? Not quite. Full audits are expensive and take a lot of time. If we are being charitable, Binance has shown a lot of good faith in moving toward transparency with its new Proof of Reserves system. This latest report is also a step in the right direction, even if it’s not as big a step as we’d like.