Disclaimer: The article has been updated to reflect Binance CEO CZ’s response to concerns raised by Kraken CEO Jesse Powell.
The collapse of cryptocurrency exchange FTX revealed the importance of proof of reserves in avoiding situations involving misappropriation of user funds. While exchanges have begun proactively sharing wallet addresses to prove users’ funds exist, many entrepreneurs, including Kraken CEO and co-founder Jesse Powell, have called the practice “futile” because the exchanges fail to include the liabilities.
According to Powell, a full proof-of-reserve audit should include the sum of the client’s liabilities, user-verifiable cryptographic proof that each account was included in the sum and signatures proving the custodian’s control of the portfolios. While the Kraken directory allows the reserve to check assets against the company’s liabilities, Powell continues to call out other players who missed including accounts with negative balances.
I’m sorry but no. This is not PoR. This is either ignorance or willful misrepresentation.
The Merkle tree is just hand-corrugated crap without a validator to make sure that no accounts with negative balances are included. A statement of assets is meaningless without liabilities. https://t.co/b5KSr2XKLB
– Jessie Powell (@jespow) November 25, 2022
Powell has called out CoinMarketCap in the past for sharing incomplete proof of reserves, as it lacks “cryptographic evidence of customer balances and portfolio control.” He reiterated that reserves are not a list of portfolios but rather assets minus liabilities.
Binance’s recently released Proof of Reserves system allows users to verify their assets using the Merkle tree. However, Powell shared his displeasure that the system failed to include accounts with negative balances, stating the following:
“The whole point of this is to understand if an exchange has more cryptocurrencies in custody than it owes to customers. Putting a hash on a row ID is worthless without anything else.”
He also called on the media and journalists to refrain from “exaggerating it and misleading consumers.” Instead, he recommended taking the time to understand the motivation behind Proving Reserves.
On the other hand, few community members disapproved of Powell’s need for a trusted auditor. In the wake of the accusation, Binance CEO Changpeng “CZ” Zhao refuted by sharing Binance’s upcoming plans to include third-party auditors to review the exchange’s Proof of Reserve results.
CZ’s response to the concerns raised by the Kraken CEO has received positive support from the community. However, some members pointed out the hypocrisy of CZ disabling public comment on the post welcoming “questions and reviews”.
Related: Crypto exchange Kraken freezes accounts related to FTX and Alameda
On November 19, CZ confirmed that it had begun work on building a secure centralized exchange (CEX), an idea floated by Ethereum co-founder Vitalik Buterin.
In this case, the best case scenario would be to build a system that does not allow cryptocurrency exchanges to withdraw depositor funds without consent.