Binance’s proof-of-reserves is just another black box

The exchange's "audit" didn't do much to calm skeptics
Assuring investors.
Assuring investors.
Photo: Costas Baltas (Reuters)
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When the crypto market melted down, Binance appeared as both the main antagonist and market savior. The exchange started the run that felled its rival, FTX, and has since promised to help bail out struggling crypto firms.

Binance also led the way in offering to prove to its customers and the broader market that it has the assets it says it does, which is known as proof-of-reserves. Specifically, Binance claims that it performed a “Merkle tree” proof-of-reserves audit, which is a cryptographic way of collecting blockchain data and making it more easily accessible.

At first glance, the unadjusted breakdown of Binance’s assets and liabilities shows a $245 million hole. However, Binance’s auditor Mazar claims that this is because Binance holds collateral for lent out bitcoin that was out of the audit’s “scope.”

“Keep in mind that some people, through margin and loans, may have used other tokens (‘out-of-scope assets’) to borrow BTC,” a Binance spokesperson said in an emailed statement. “If we take these loaned BTC assets into account (in other words if we didn’t provide these BTC loans, which may be collateralized in other assets), we would be 101% collateralized for BTC. As we provide further updates to our PoR in the coming weeks, we will bring more tokens in scope and it will be even clearer that assets are greater than liabilities.”

Former SEC regulator John Stark told Decrypt that there were several red flags with the audit, including using Mazar, instead of a big-four auditing firm, and being able to dictate the terms of the audit. Mazar also did not issue an official opinion on the effectiveness of the audit it performed.

For its part, Binance said that it had contacted Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers, but said that the firms were hesitant to conduct a “proof of custody” report for a private exchange.

“As a result, we contacted Mazars, who has experience working in the crypto space, to conduct an ‘agreed upon procedures’ (AUP) analysis similar to what Kraken publishes,” the Binance spokesperson said. “AUP is the term accounting firms use when they’re hired to do a specific test or to review a business process, rather than do a full company audit.”

The future of Binance’s finances are also in question as the US Department of Justice (DOJ) weighs charging the exchange with anti-money laundering and sanctions violations, according to a new report in Reuters.

The exchange’s lawyers are allegedly talking with the DOJ about the possibility of entering into plea deals for exchange executives, including CEO Changpeng Zhao, instead of fining the exchange.

“As has been reported widely, regulators are doing a sweeping review of every crypto company against many of the same issues,” the Binance spokesperson said. “This nascent industry has grown quickly and Binance has shown its commitment to security and compliance through large investments in our team as well as the tools and technology we use to detect and deter illicit activity.”

How did we get here?

November 2: CoinDesk published a story revealing that a chunk of Alameda’s balance sheet was made up of FTX’s native exchange token FTT.

November 6: Binance sells its FTT tokens, pushing down the price of FTT and starting a run on FTX.

November 8: Binance offers to buy rival FTX.

November 9: Binance rescinds the buyout offer.

November 11: FTX files for Chapter 11 bankruptcy.

November 25: Binance says it will set up a $1 billion recovery fund for the industry.

Updated with comment from Binance.