- Other crypto firms have tried to boost trust and transparency after the collapse of FTX.
- Binance and other rivals promoted proof of reserves to be a solution.
- Experts don’t believe that proof of reserves will be enough to restore trust in crypto exchanges.
The collapse of FTX has raised questions about cryptocurrency firms’ ability pay customers when they panic. Industry leaders have promoted “proof of reserves” to increase confidence.
However, experts doubt that it is sufficient because the FTX bankruptcy exposed a range of counterparty risk that crisscrossed the sector.
Binance, the world’s biggest crypto exchange according to trading volume, has promised to conduct proof of reserves. Changpeng Zhao, Binance CEO, stated that it would foster “full transparency”between exchanges, and their clients.
What is evidence of reserves?
A proof of reserves is performed by a third party. This basically confirms that the stated holdings exist. This could provide detailed information about the assets and their movements.
Although proof of reserves can show customers that money is not being lent out but is still valid, it doesn’t tell the whole story.
Experts say clients are often unaware of key risks. Proof of reserves is only a snapshot and can be misleading.
Here’s the catch, with evidence of reserves
Insider was told by Martin Hiesboeck (head of crypto and blockchain research at Uphold), that “Proof Of Reserves” has been a clever way to save crypto. However, it has two major flaws.”
It shows the balances at a specific time, but does not account for any in-and out movement of assets that could produce a momentary equilibrium.
Hiesboeck cited a recent Crypto.com incident, where it was reported that it had transferred $400 million worth cryptocurrencies from one exchange to another before it recovered the money. Skeptics suggested that such transfers could strengthen proof of reserve.
Second, a glaring gap in proof of reserves is the absence of liabilities, which make the assets look misleading, according to Hiesboeck.
“Have ever you seen a company financial statement that didn’t include liabilities? He stated that it would be incomplete.
According to Ahmed Ismail (CEO of liquidity aggregator Fluid), proof of reserves does not yet have the ability to determine whether customer funds were commingled or whether there are off-balance sheet liabilities.
Instead, they should look to secure user funds and deposit, much like traditional finance guarantees for retail bank deposits.
Merkle tree evidence of reserves
Merkle tree proofs are also possible solutions that work in realtime. A Merkle tree is a data structure that encodes blockchain transactions more securely, tracking assets from their origin to their destination.
It promises “…tamper-proof“Security” exchanges can just as easily place client money in peril by lending to more risky clients.
Rishabh, director of operations at TDeFi, stated that tracking doesn’t stop exchanges/custodians giving money to unvetted borrowers who may not be able repay the loan. Governance is required to ensure funds are properly used in such instances.
