Friday, January 27, 2023

Binance proof of reserves is ‘pointless without liabilities:’ Kraken CEO

Disclaimer: The article has been updated to reflect Binance CEO CZ’s response to the concerns raised by Kraken CEO Jesse Powell.

The collapse of the crypto exchange FTX revealed the importance of proof of reserves in avoiding situations involving the misappropriation of users’ funds. While exchanges have proactively started sharing wallet addresses to prove the existence of users’ funds, several entrepreneurs, including Kraken CEO and co-founder Jesse Powell, called the practice “pointless” as exchanges fail to include liabilities.

According to Powell, a complete proof-of-reserve audit must include the sum of client liabilities, user-verifiable cryptographic proof that each account was included in the sum and signatures proving the custodian’s control over the wallets. While Kraken’s proof of reserve does allow verification of assets against the company’s liabilities, Powell continues to call out other players that have missed out on including accounts with negative balances.

Powell called out CoinMarketCap in the past for sharing incomplete proof of reserves, as it lacked “cryptographic proof of client balances and wallet control.” He reiterated that reserves are not the list of wallets but assets minus liabilities.

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Binance’s recently released proof-of-reserves system allows users to verify their assets using a Merkle tree. However, Powell shared his displeasure as the system failed to include accounts with negative balances, stating that:

“The whole point of this is to understand whether an exchange has more crypto in its custody than it owes to clients. Putting a hash on a row ID is worthless without everything else.”

Moreover, he asked the media and journalists to refrain from “overselling it and misleading consumers.” Instead, he recommended they take the time to understand the motive behind proof of reserves.

On the other hand, few community members refuted Powell’s need for a trusted auditor. Following up on the accusation, Binance CEO Changpeng “CZ’ Zhao refuted by sharing Binance’s upcoming plans that involve third-party auditors to audit the exchange’s proof-of-reserve results.

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The response from CZ to the concerns raised by Kraken CEO received positive support from the community. However, some members pointed out the hypocrisy that CZ disabled public commentary on the post that welcomed “questions and checks.”

Related: Crypto exchange Kraken freezes accounts related to FTX and Alameda

On Nov. 19, CZ confirmed to have started working on building a safe centralized exchange (CEX), an idea put forth by Ethereum co-founder Vitalik Buterin.

In this instance, the best-case scenario would be building a system that does not allow crypto exchanges to withdraw a depositor’s funds without consent.