Close up of computer code, like the cryptographic language behind Merkel’s Proofs of Proofs by … [+]
CoinMarketCap.com, the world’s largest crypto data website, announced via Twitter November 22, the launch of a feature showing Proof of Reserves (PoR) for crypto exchanges. Users of the site’s popular exchange page tables, which received approximately 104 million visits in September, will now see a small mark next to the names of seven exchanges that have recently jumped on the proof-of-reserve bandwagon: Binance, Kucoin, Bitfinex, Crypto.com, Huobi, OKX and Bybit.
Surprisingly, the list did not include the names of five other crypto exchanges that have publicly announced that they are conducting full proof-of-reserves checks: Kraken, Gate.io, BitMEX, Coinfloor, and HBTC.
HBTC
The current format of the data shows Binance as the exchange with the largest reserves, but there is no discussion that, as appears to have been the case at FTX, Binance’s reserves might be crowded or deficient. one way or another. The company’s limited discussion and selective set of exchanges to launch its product suggests favoritism that could ultimately erode trust.
CoinMarketCap Proof of Reserves Feature
Screenshot of Binance financial reserves according to CoinMarketCap.com
Fruit basket PoR
Proof of reservations comes in different forms. The elements present in a serious discussion on the PoR specify:
- Whether the data is auditor-assisted or self-assessed
- If it offers users so-called Merkle validation
- Whether validation is continuous or for particular points in time
Audited-assisted includes expertise lent by a third party. A Merkle validation allows users to cryptographically verify that they own a unique hash counted against the exchange’s inventory. Exchanges that offer full proof of reserves benefit from both auditor assistance and Merkle user validation.
Thus, the CoinMarketCap feature displays a near real-time measurement of the asset reserves of selected exchanges in designated wallets, but the accuracy of the information is not guaranteed. Additionally, the numbers are unaudited and do not offer end-user Merkle validation.
Kraken CEO Jesse Powell responded to CoinMarketCap’s announcement saying via Twitter that “auditing proof of reserves requires cryptographic proof of client balances and control of the wallet”, and this must include independent attestation of liabilities (which controls the proceeds of the wallet).
Powell further asserted that proof-of-asset audits should have the following three elements:
- Sum of client liabilities (auditor should exclude negative balances)
- User-verifiable cryptographic proof that each account was included in the sum
- Signatures proving that the custodian has control of the portfolios
Meaningless data
Exchanges based in island tax havens lack basic regulatory oversight and can publicly declare that they own this or that wallet containing so many tokens, while failing to disclose that they have pledged those tokens, so that in reality, they are not freely available to customers.
The risk of meaningless PoR data will likely remain until exchanges agree to submit financial statement disclosures to credible auditors who can attest that companies have strong internal controls. Alternatively, an exchange could submit to regulators who perform random audits, for added credibility.
CoinMarketCap reveals that its proof of reserve pages have affiliate links that generate revenue for the company.
Takeaway for investors
Proof of reservations is a topic that will only get hotter. CoinMarketCap’s announcement illustrates its importance in what is a first step. The company’s treatment of this feature seems biased and sloppy and lacks the depth evident in other parts of its website.
