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Which Crypto Exchanges Have Released Proof-of-Reserves?
The crypto industry is still reeling after one of the largest exchanges collapsed in spectacular fashion within a matter of days. FTX was valued at $32 billion earlier this year. However, this evaluation, along with retail and institutional investors’ digital assets, were erased almost overnight in one of the most shocking blow-ups in history.
We learned from the bankruptcy filing that there was virtually zero oversight or proper recording of users’ funds within the exchange. Those same user funds were used as collateral to cover heavy losses in SBF’s quantitative crypto trading firm Alameda Research.
FTX’s collapse is a significant blow to the crypto industry’s already bruised reputation from the earlier 2022 black swan events. In a rush to re-establish trust and confidence in the industry, other exchanges have started publishing their proof-of-reserves to prove they remained solvent.
What is a Proof-of-Reserves?
Proof-of-reserves is an independent audit conducted by a third-party to ensure that a custodian holds the assets it claims to have. It is achieved through user-verifiable cryptography that takes a snapshot of an exchange’s balances and arranges them into a Merkle tree. This is a form of cryptography that allows auditors the ability to verify the balances without requiring the need for disclosing private keys.
Some of the biggest failures to be revealed in the FTX collapse were:
- It did not hold its customer’s assets on a 1:1 ratio
- It was not regularly audited
- Customer deposits weren’t recorded on the balance sheet, and
- It had no cash management system
Implementing a proof-of-reserves helps determine and solve these issues, if done right.
Which exchanges have released proof-of-reserves?
Below, we explore crypto exchanges and their rationale around releasing, or withholding, Proof-of-Reserves.
Kraken
One of the most vocal critics of FTX and its failures has been the CEO of Kraken, Jesse Powell. His critiques are much more than a competitor’s grievances. The lack of oversight at FTX is in stark contrast to Kraken, which by most accounts, has been one of the most secure and transparent crypto exchanges regarding its storage of customers’ assets.
Kraken performs biannual verified audits on its reserves by an independent top-25 global accounting firm. In early 2022, Armanino LLP conducted the most recent audit determining that Kraken held $19 billion worth of its clients’ bitcoin and ether in cold storage. This included $3.5 billion in Kraken’s on-chain staking service for eth2.
Coinbase
Coinbase is unique in its approach to proof-of-reserves. They have not provided an updated proof-of-reserves since the collapse of FTX, yet this may not be as big of an issue compared to other exchanges that have yet to do so.
Coinbase is a publicly traded company that operates on the stock exchange. To maintain its public listing, Coinbase is subject to a quarterly external auditor review. In addition, Coinbase also files annual financial statements with the SEC, is required to prove ownership of customers’ addresses, and provide evidence of its cold and hot storage controls.
It is one of the most regulated exchanges on the market. It is also exploring offering cryptographic proof-of-reserves-and-liabilities via Merkle trees, similar to how other exchanges are for absolute clarity.
Binance
FTX was not the only exchange that caught the ire of Jesse Powell. Binance was one of the first to publish its proof-of-reserves, doing so on November 25th, 2022. However, Mr. Powell, amongst others, was quick to critique the disclosed holdings. The issue he highlighted was the token allocation:
BUSD: 30.61%
USDT: 22.76%
BTC: 13.97%
BNB: 10.70%
ETH: 8.74%
Others: 13.22%
Total: $67 Billion
Notably, over 30% of Binance’s holdings were in USDT and the Binance native utility token BNB. USDT has a murky history and has become depegged on several different occasions. FTX got into solvency issues after holding too much of their FTT utility token on their balance sheets.
Yet the biggest issue with Binance’s proof-of-reserves is that they omitted their liabilities. With over 30 million users on the Binance platform, Binance likely has significant liabilities (users storing digital assets on the platform) that could exceed their assets. This would create a liquidity crisis for the exchange if there were a bank run.
Still, Binance, has been remarkably resilient over the years and has proven that it can process customer withdrawals at scale.
Greyscale
While not a crypto exchange, Grayscale is the largest digital-native asset manager and provides indirect exposure to Bitcoin through its Grayscale Bitcoin Trust GBTC. The GBTC tracks the price of Bitcoin and issues shares that investors can hold at their legacy brokerages. Grayscale claims to be the largest legal holder of Bitcoin, with around 633,000 BTC.
Yet, in a time when exchanges are rushing to prove ownership of digital assets, Grayscale has shied away. Instead, Grayscale holds its Bitcoin through Coinbase Custody cold storage and defended its lack of disclosure due to security concerns. Coinbase Custody confirmed Grayscale’s assets were secure but did not disclose how much they were storing.
The funny thing about Bitcoin is that it is open source, allowing chain forensics to help identify addresses. So far, OXT research has been able to identify 432 addresses with 317,705 BTC as likely GBTC holdings. This is only about half of the assets that Grayscale claims to hold.
While OXT is still investigating, it’s likely this is only part of the holdings of Grayscale. Grayscale may hold the entirety of the assets they claim, yet, in a period of obfuscation and distrust of custodians, it is strange Grayscale has chosen not to disclose its proof-of-reserves.
Overview: Proof-of-Reseves Better Than Nothing
Many people need to remember that cryptocurrencies were designed to eliminate the need to rely on third-party intermediaries. Crypto is engineered to eliminate the need for trust in the system.
Centralized exchanges reinsert trust into the system which FTX was able to abuse to enrich itself and its founder, Sam Bankman-Fried. Proof-of-reserves provide a chance for partial clarity but, at the end of the day, only represents a snapshot in time. Nevertheless, it may be the best option we have for now.
