Even as FTX and the saga of its collapse continues to dominate the headlines in the crypto space and beyond, there are numerous other headlines that are (arguably) more important for the health of the sector moving forward. With it increasingly looking like, and the charges of fraud confirming this, that FTX was fraudulently marketed and run from the very beginning, the blockchain and crypto sector need to think about moving on from this disaster.
Notably, the instability, massive withdrawals totaling nearly $3 billion over a 24-hour period, the pause of withdrawals of the USDC stablecoin, and possibiltiy of legal charges being brought against Binance should be giving all market watchers cause for, at least, questions.
Accounting and financial reporting, notwithstanding the renewed focus being paid to these topics as a result of the fraud charges recently released against Samuel Bankman-Fried, generally do not make headlines nor attract mainstream interest. That said, the concept of Proof-of-Reserves, an accounting process that seeks to add more transparency to the crypto space, has been thrust into the spotlight since November 2022. With organizations including Binance and Crypto.com embracing the concept – albeit attracting quite a few critiques along the way - following in the footsteps of Kraken which spearheaded this reporting process, the question needs to be asked; is PoR up to the task?
Let’s break down what exactly happened at Binance, and how PoR ties into this evolving story?
What is Proof-of-Reserves? Even trying to define what a PoR engagement is has proven to be difficult, with multiple firms and organizations putting forward alternate definitions, and with multiple crypto organizations issuing a wide array of information under the title of a PoR report. Due to the lack of standardization around crypto auditing, and lack of authoritative accounting standards directly connected to crypto accounting and reporting, the market is still working toward consensus around these topics.
A working definition that should work in most cases is that PoR engagements seek to increase transparency around what assets are held by the exchange or issuer in question, that assets listed on external finance assets do exist as reported, and to generally reassure investors and regulators that the entity in question is operating in good faith.
This concept, although promising and having been seized on as a viable tool to help with crypto reporting and transparency, is not a cure-all tool. That said, PoR is not an auditing standard or consistently applied process, and firms that have released PoR information have demonstrated a wide range of results.
In the aftermath of FTX, which came at the end of a devastating year for centralized exchanges and crypto issuers, there is a clear need for better reporting, real-time analytics, and less opacity with regards to how these firms operate. When looking at what has been occurring at Binance – massive withdrawals, halting withdrawals, and token swaps not providing promised benefits – improving the consistency and comparability around PoR is critically important.
What happened? Reported on December 13, Binance had suffered nearly $3 billion in withdrawals in the past 24 hours, causing the exchange to temporarily halt customer withdrawals of the USDC stablecoin. Especially with the rattled nerves of crypto investors in the aftermath of FTX, and happening within hours of Samuel Bankman-Fried being arrested in the Bahamas, this led to further speculation about the health of the platform.
CEO Changpeng Zhao attempted to assuage market jitters via a series of tweets, explaining that the pause in customer withdrawals was not due to the any leverage or margin issue, like those that started the unraveling of FTX. Rather, he stated that the withdrawals were due to the lack of traditional U.S dollars, and that once U.S. banks were open for business the issue would be resolved. Specifically, Binance experienced some liquidity issues with the token swaps that the institution needed to complete in order to meet the heightened demand for withdrawals, which raises another question that adds more fuel to the proverbial fire.
Any time that an exchange, crypto or not, has to pause withdrawals, investors and regulators are going to want to know – exactly – why this is the case. In the case of Binance it seems like a recently announced change, increasing the importance of Binance USD (the native token of the exchange), played part in this liquidity crunch; token swaps.
What do token swaps have to do with customer funds? In September 2022 Binance instituted a change in its stablecoin policy, where the exchange would automatically convert current user balances, as well as new deposits of USD Coin, Pax Dollar, and True USD into Binance USD. Binance USD is a stablecoin issued and managed directly by Binance, which after the revelations around how FTX utilized its native token, is certainly worthy of a second look.
Put simply, the promised benefits of this change did not manifest when Binance needed them the most. Especially since some of the projected benefits of this change in stablecoin policy were greater liquidity for trading purposes, along with still allowing users to withdraw funds denominated in tokens other than Binance USD, the fact that this did not work as advertised can be seen as further fueling the scrutiny that Binance is under. Swapping assets for other assets, and having to pause customer withdrawals, all while rumors of legal charges swirl around the exchange in question is never a recipe for success.
Specifically, the questions and scrutiny around how PoR engagements, which promise to increase the transparency and traceability of exchanges, actually work when met with reality are items that should remain a priority for regulators and standard-setters for the foreseeable future. The PoR report released by Binance after the collapse of FTX, but before the issues the exchange has experienced itself, has arguably raised more questions than answers; much work remains to get these engagements to where they can be relied on by market participants.
Binance is simultaneously the worlds largest crypto exchange, and also a player in the space that has been dogged by allegations and investigations for years. Crypto needs, and deserves, reporting and standards that provide transparency, understandability, and can be applied consistently. The jitters and nervous questions caused by the pause of USDC withdrawals at Binance reinforce just how important getting crypto reporting right is for a healthy and liquid market.