Disclaimer: The article has been updated to reflect Binance CEO CZ’s response to concerns raised by Kraken CEO Jesse Powell.
The collapse of the FTX cryptocurrency exchange highlighted the importance of proof of reserves to avoid situations of misappropriation of user funds. Although exchanges have begun to proactively share wallet addresses to prove the existence of user funds, several entrepreneurs, including Kraken CEO and co-founder Jesse Powell, called the practice “useless” as that exchanges do not include responsibilities.
According to Powell, a full proof-of-reserve audit should include the sum of client liabilities, user-verifiable cryptographic proof that each account was included in the sum, and signatures demonstrating custodian control over the portfolios. . Although Kraken’s reserve test allows you to check the company’s assets against liabilities, Powell continues to call attention to other players who have failed to include accounts with negative balances.
I’m sorry but no. This is not PoR. This is either ignorance or intentional misrepresentation.
The merkle tree is just hand wavey bullshit without an auditor to make sure you didn’t include accounts with negative balances. The statement of assets is pointless without liabilities. https://t.co/b5KSr2XKLB
—Jesse Powell (@jespow) November 25, 2022
Powell called out CoinMarketCap in the past for sharing incomplete proof of reserves, as it lacked “cryptographic proof of client balances and portfolio 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 dissatisfaction that the system did not include accounts with negative balances, stating that:
“The goal of this is to understand if an exchange has more crypto in its custody than it owes to clients. Putting a hash on a row id is worthless without everything else.”
In addition, he asked the media and journalists to refrain from “exaggerating and misleading consumers.” Instead, he recommended that they take the time to understand the reason for the reserve test.
On the other hand, few members of the community disputed Powell’s need for a trusted auditor. Following up on the allegation, Binance CEO Changpeng “CZ’ Zhao rebutted by sharing Binance’s upcoming plans involving third-party auditors to audit the exchange’s reserve test results.
CZ’s response to the concerns raised by the Kraken CEO received positive support from the community. However, some members pointed out the hypocrisy of CZ disabling public comments on the post that hosted “questions and checks.”
On Nov. 19, CZ confirmed that he has started work on building a secure centralized exchange (CEX), an idea proposed by Ethereum co-founder Vitalik Buterin.
In this case, the best scenario would be to build a system that does not allow cryptocurrency exchanges to withdraw a depositor’s funds without their consent.
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