Kraken’s Powell says Binance Proof-of-Reserve is pointless without liabilities

Former Kraken CEO Jesse Powell criticized Binance’s Proof of Reserve, calling it an “ignorant or intentional misrepresentation.”

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 argued that the Merkle Tree was pointless if there were no external auditors to ensure that the exchange did not include accounts with negative balances.  He added that “the statement of assets is pointless without liabilities.”

The whole point of this is to understand whether 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.

What is missing in Binance Proof-of-Reserve?

Popular crypto investor Vinny Lingham tweeted on Nov. 27 that exchanges should publish their Proof-of-Liabilities alongside their Proof-of-Reserves. According to him, some exchanges could have liabilities beyond their deposits.

Exchanges publishing Proof-of-Reserves is just a distraction. We also need Proof-of-Liabilities to go with it.

E.g. I could have proof that I have $1bn in deposits but if I owe depositors $2bn, then that’s meaningless.

Let’s not make the same mistake again.

— Vinny Lingham (@VinnyLingham) November 12, 2022

Meanwhile, James Lavish, the author of The Informationist newsletter, wrote that Powell’s view required third-party auditors, which means trusting human sources of information. According to Lavish, previous trusts in such parties have not turned out well for the community.

He referenced how several parties involved with FTX said it was safe and solvent but collapsed.

CZ responds

Binance CEO Changpeng Zhao has since responded to Powell’s view. According to him, Binance has plans to involve third-party auditors later on, and the exchange proof of reserves does not include negative balances.

And absolutely no negative balances involved. It will be verified in the audit for the above PoR.

Actually the first time I heard about a "negative balance" in a PoR. "Innovative"…

We welcome questions and checks. Let's build together.

— CZ Binance (@cz_binance) November 26, 2022

He added that this was the first time he saw the term “negative balance” and welcomed all questions and checks.

CZ revealed on Nov. 28 that Binance was undergoing the Proof-of-Reserve audit. He said the exchange was ordered to send a specific amount to itself to prove that it controls the wallet.

This is part of the Proof-of-Reserve Audit. The auditor require us to send a specific amount to ourselves to show we control the wallet. And the rest goes to a Change Address, which is a new address. In this case, the Input tx is big, and so is the Change. Ignore FUD! https://t.co/36wUPphIZk pic.twitter.com/2NkH5L5J9j

— CZ Binance (@cz_binance) November 28, 2022

While some people commended CZ’s response, others criticized his “hypocrisy” for disabling public comments from the tweet despite asking for questions and checks.

Following the collapse of FTX, the need for exchanges to prove their solvency has led to an emphasis on Merkle Tree’s proof of reserves.

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