by Disclaimer: Article updated to reflect Binance CEO CZ’s response to Kraken CEO Jesse Powell’s concerns.
The collapse of crypto exchange FTX has highlighted the importance of proving reserves to avoid situations involving misappropriation of user funds. While exchanges have proactively started sharing wallet addresses to prove the existence of user funds, several entrepreneurs, including Kraken CEO and co-founder Jesse Powell, have called the practice “pointless” because exchanges hold no liabilities.
According to Powell, a full proof-of-reserve audit must include the total of customer liabilities, user-verifiable cryptographic proof that each account was included in the total, and signatures demonstrating the custodian’s control of the wallets. While Kraken’s Proof-of-Reserve allows assets to be checked against the company’s liabilities, Powell continues to call out other players who missed recording accounts with negative balances.
Sorry, but no. This isn’t a POR. This is either ignorance or willful misrepresentation.
The Merkle tree is just handwaved bullshit without an auditor to make sure you don’t include negative balance accounts. The statement of assets is meaningless without liabilities. https://t.co/b5KSr2XKLB
— Jesse Powell (@jespow) November 25, 2022
Powell has called CoinMarketCap in the past for sharing an incomplete proof of reserves due to a lack of “cryptographic proof of customer balances and wallet control.” He reiterated that reserves are not the wallet list, but assets minus liabilities.
Binance’s recently released Proof-of-Reserve system allows users to verify their assets using a Merkle tree. However, Powell shared his displeasure at the system’s disregard for accounts with negative balances, stating:
“The key point here is to understand if an exchange has more crypto in its custody than it owes to customers. Putting a hash on a row ID is worthless without anything else.”
He also urged the media and journalists “not to overdo it and mislead consumers”. Instead, he advised them to take the time to understand the motive behind the proof-of-reserves.
On the other hand, few parishioners refuted Powell’s need for a trustworthy examiner. Following the allegation, Binance CEO Changpeng “CZ” Zhao refuted by sharing Binance’s forthcoming plans to bring in external auditors to review the results of the exchange’s reserve evidence.
CZ’s response to the concerns raised by Kraken’s CEO has received positive support from the community. However, some members pointed out the hypocrisy that CZ disabled public comment on the post, which welcomed “Questions and Checks.”
Related: Crypto exchange Kraken freezes accounts related to FTX and Alameda
On November 19, CZ confirmed it had started work on building a secure centralized exchange (CEX), an idea put forward by Ethereum co-founder Vitalik Buterin.
In this case, the best scenario would be to build a system that would not allow crypto exchanges to withdraw a depositor’s funds without consent.
