Disclaimer: The article has been updated to reflect Binance CEO CZ’s response to concerns raised by Kraken CEO Jesse Powell.
The collapse of crypto exchange FTX revealed the importance of proof of reserves to avoid situations of embezzlement of user funds. As exchanges have begun to proactively share wallet addresses to prove the existence of user funds, several entrepreneurs, including Jesse Powell, CEO and co-founder of Krakencalled the practice “unnecessary” because the exchanges do not include liabilities.
According to Powell, a full proof of reserve audit should include the sum of the client’s liabilities, user-verifiable cryptographic evidence that each account was included in the sum, and signatures proving the custodian’s control over the wallets. While Kraken’s proof of reserve helps verify the company’s assets against liabilities, Powell continues to call out other players who failed to include accounts with negative balances.
I’m sorry but no. It’s not PoR. It’s either ignorance or intentional misrepresentation.
The Merkle tree is just bullshit with no auditor to make sure you haven’t included accounts with negative balances. The state of the asset is useless without a liability. https://t.co/b5KSr2XKLB
— Jesse Powell (@jespow) November 25, 2022
Powell has called out CoinMarketCap in the past for sharing incomplete proof of reserves because it lacked “cryptographic proof of customer balances and wallet control.” He reiterated that reserves are not the list of portfolios but assets minus liabilities.
Binance’s recently released proof of reserves system allows users to verify their assets using a Merkle tree. However, Powell shared his displeasure that the system did not include accounts with negative balances, stating that:
“The point of all of this is to understand if an exchange has more crypto in its custody than it owes customers. Putting a hash on a row ID is worthless without everything else.
Moreover, he asked the media and journalists to refrain from “overselling and misleading consumers”. Instead, he recommended that they take the time to understand the motive behind proving reservations.
On the other hand, few in the community disputed Powell’s need for a trusted listener. Following the accusation, Changpeng ‘CZ’ Zhao, CEO of Binance rebutted by sharing Binance’s upcoming plans that involve third-party auditors to audit the exchange’s proof of reserve results.
CZ’s response to concerns raised by Kraken’s CEO has received positive support from the community. However, some members pointed out the hypocrisy that CZ disabled public comments on the post which welcomed “questions and verifications”.
On November 19, CZ confirmed that they had started work on building a secure centralized exchange (CEX), an idea put forward by Vitalik Buterin, co-founder of Ethereum.
In this case, the best-case scenario would be to build a system that does not allow crypto exchanges to withdraw funds from a depositor without their consent.