- Despite the fact that Binance has offered proof of reserves for its Bitcoin holdings and these have been audited by a third-party company, there are still a few points to answer.
- The audit was conducted by Mazars, an auditing, accounting and consulting company which on December 7 published a report on Binance’s proof of reserves.
- Francine McKenna, a professor of financial accounting at The Wharton School of the University of Pennsylvania, said the Mazars assessment cannot be considered an official audit.
last november 25 Binance launched its Proof of Reserves system which allows all users of the exchange to verify the reserves of the crypto signature in Bitcoin through a system based on Merkle Trees.
This solution was launched by the crypto exchange after the FTX crash, which is why Binance CEO Changpeng Zhao pledged to increase the transparency of the cryptocurrency industry by offering proof of his reserve.
On November 30 specifically, Binance published the proof-of-reserve data for its Bitcoin (BTC) holdings in particular. The crypto exchange assured that it carried out an audit, or ‘audits’ in English, using the ‘Merkle Tree’, which consists of a cryptographic way of collecting data on the Blockchain and making it accessible.
In this breakdown, Binance claimed to have on-chain reserves of 582.5 thousand BTC while the net balance of its users was 575.7 thousand BTC. This meant that, in theory, Binance had a 101% booking rate.
However, in its press release Binance warned that these results had not yet been audited by third parties and, in fact, that would be the next step to take.
The fact is thatContrary to achieving a greater feeling of security among users, Binance’s attempt at greater transparency has raised important alerts. Below we will explain how Binance is doing its proof of reserves and why it is receiving so much criticism.
What is happening with Binance’s proof of reserves?
Let’s start by understanding how Binance is offering proof of your reserves. As we mentioned before, Binance makes use of the Merkle Tree, so that users can verify their assets within the platform.
The Merkle Tree is a cryptographic tool that allows consolidating large amounts of data into a single hash. In this hash, all the data entered will be summarized.
As Binance explains, the new feature allows each client to verify their BTC holdings. To do this, you must enter the main page of Binance, click on “Wallet” and then on “Audit”. There each user will find their Merkle Leaf together with their registration ID.
Based on this methodology, Binance claimed that its clients with Bitcoin holdings were over-collateralized because the crypto exchange had a 101% reserve rate. But this is where the role of the auditor comes in.
Binance requested an external audit
Since there could be a conflict of interest in the presentation of this type of information, an external audit is required to analyze the information and ensure its veracity. This is where Mazars comes in, an auditing, accounting and consulting company that was founded in 1945.
December 7 Mazars public a report on the Binance reserves test where the auditing company assured that, at the time of the evaluation, “the assets controlled by Binance exceed 100% of the total liabilities of its platform.” However, many say that the audit carried out is extremely useless and leaves many gaps to be answered.
To conduct the assessment, the auditing firm took a snapshot of Binance’s total reserves and liabilities on Nov. 22. Assets included those in spot, options, margin, futures, financing, loan, and profit accounts for BTC, Wrapped Bitcoin, Ethereum, BNB Chain, and Binance Smart Chain.
The report itself is an agreed upon procedure (AUP) but not an assurance engagement. Namely, not mazars express an opinion nor do they reach an assurance conclusion with their audit. This implies that the audit cannot ensure that the evidence obtained is sufficient and appropriate to offer a conclusion on whether the sources are free from misrepresentation.
What are the concerns?
Despite the fact that Binance has offered proof of reserves for its Bitcoin holdings and, in addition, they have been audited by a third-party company, there are still a few points to answer.
According to accounting and financial specialists who were consulted by The Wall Street JournalBinance’s recent efforts raised some red flags about the crypto exchange.
Specialists highlight the fact that The Mazars report does not provide information regarding the quality of the crypto exchange’s internal controls as well as how Binance’s systems work to liquidate assets to cover margin lending.
Also, Mazars report shows that Binance reserves are actually 97% guaranteed when assets lent to users are excluded. This means that the audit found that there is not a 1:1 ratio of client reserves to assets.
“We found that Binance was 97% collateralized without taking into account out-of-scope assets pledged by clients as collateral for in-scope assets provided through the lending and margin service offering, resulting in negative balances on the Customer Responsibility Report. Including In-Scope Assets lent to clients via margin and loans that are over-collateralized by Out-of-Scope Assets, we found that Binance was 101% collateralized.” notes the report.
According to QZ, a Binance spokesperson said to note that some people may have used other tokens to borrow BTC. So, it is expected that as they provide more updates to the proof of reserves and more tokens are added, it will become clearer that the assets are greater than the liabilities.
Why was Mazars chosen?
The specialists asked themselves the following question: Why Mazars and not another of the Big Four audit firms? According to QZ, Binance said that it had sought to contact audit firms such as Deloitte, Ernst & Young and KPMG but that they hesitated on whether to produce an audit report.
“As a result, we contacted Mazars, who has experience working in the crypto space, to perform an ‘agreed-up procedures’ (AUP) analysis similar to the one Kraken publishes.” the Binance spokesperson told QZ.
In accordance with DecryptJohn Reed Stark, a former US Securities and Exchange Commission (SEC) regulator, explained that the Mazars audit report is like sending someone to inspect a home for fire safety and that someone say that you are not sure that your inspection procedures were good.
Also, according to CoinDesk, Francine McKenna, a professor of financial accounting at The Wharton School of the University of Pennsylvania, said the Mazars assessment cannot be considered an official audit. In fact, Professor McKenna claimed that it is “more useless than even the Tether or USDC report.”
FUD spreads rapidly
Binance has recently been embroiled in three main controversies:
- The United States Department of Justice could indict Binance executives for money laundering, according to Reuters. Binance assured that Reuters is wrong.
- Binance stops withdrawals for some accounts for USDC. As of this writing, withdrawals have resumed according to Binance.
- Binance’s proof of reserves audit raises some red flags.
The 3 news together have generated turbulence in the crypto community. Meanwhile, Changpeng Zhao invited users to ignore the FUD and keep building.
Without a doubt, Binance seems to be obliged to improve the quality of information about its reserves that it presents in order to gain the trust of the community.
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