Binance released its highly anticipated proof of reserves (PoR) on Friday, providing blockchain-based evidence for the Bitcoin on its books.
However, many in the crypto community question Binance’s approach, and aren’t fully convinced that they have the transparency they’re looking for.
The Move to Proof of Reserves
As Binance explained in its announcement, the exchange’s transparency system will add multiple tokens and networks within the next two weeks. For now, it solely validates its Bitcoin holdings.
The company’s initial audit proved that it owns 582,486 BTC in its on-chain reserve, while its customers hold a 575,742 BTC net balance. This makes for a 101% collateral ratio.
Users can verify that their personal balance is held with Binance by checking on their relevant Merkle leaf and record ID on Binance’s website. A Merkle leaf is a transaction within a merkle tree, a structure used to efficiently store data inside a blockchain.
Binance will soon introduce third-party auditors to validate its proof of reserves results and increase the privacy of the system using ZK-SNARKs. As explained by Ethereum co-founder Vitalik Buterin, this will allow users to verify Binance’s solvency, and their own balances, but “would reveal nothing about the balance of any other user.”
Binance announced its plans to implement Merkle-tree proof of reserves after FTX proved unable to process customer withdrawals this month. Many suspect the exchange to have commingled users’ assets with Alameda Research and used them for lending without permission. On November 11th, both FTX and Alameda filed for bankruptcy.
Criticisms of Proof of Reserves
While many were excited by Binance’s efforts to reassure users with added transparency, others were skeptical that its current implementation will actually prevent another FTX-like blowup.
“I’m sorry but no. This is not PoR,” said Kraken co-founder Jesse Powell in response to Binance’s announcement. “This is either ignorance or intentional misrepresentation.”
Powell argued that hashing users’ records into Merkle trees isn’t helpful without proof that the exchange didn’t include accounts with negative balances. “The statement of assets is pointless without liabilities,” he said.
The co-founder made a similar criticism of CoinMarketCap’s PoR system, pointing out key details it lacked to make it helpful. These included an audit of the company’s liabilities, and proof that the exchange actually controls its wallets.
Kraken also uses a proof of reserves system, but includes an auditor to ensure Kraken doesn’t use negative balances to distort its numbers.
Even under a complete PoR system, Powell noted that the system still cannot prove whether a company has borrowed against client assets.
Despite the co-founder’s skepticism, Binance CEO Chanpeng Zhao welcomed the criticism. “I view these as healthy checks,” he said on Friday.
Who Else is Considering PoR?
Coinbase – Binance’s next largest competitor – announced on Friday a $500 million developer grant to craft new proof of reserves systems. The exchange clarified that it still uses traditional, audited financial statements to prove its own reserves.
Gate.io provided a proof of reserves statement late last month, but came under scrutiny after mysteriously receiving a $300 million ETH transfer from Crypto.com at the time. However, the exchange has clarified that these funds, which have been returned, were not included in the audit.
Grayscale – the world’s largest Bitcoin fund – refused to provide proof of reserves despite popular demand from the crypto community this month. “Due to security concerns, we do not make such on-chain wallet information and confirmation information publicly available through a cryptographic Proof-of-Reserve,” it said last Friday.