May 18, 2024

power-tools-pro

Technology will be Here

crypto meltdown

Are proof of reserves enough to help restore trust in crypto?

Events that ripped through the world of cryptocurrencies this year can easily be likened to a series of earthquakes.

The implosion of FTX being 9.0 on the Richter scale, with earlier scandals from Terra-Luna to Hodlnaut as the foreshocks — smaller in magnitude, but equally devastating.

Altogether, it paints a picture of an industry on the verge of collapsing upon itself like a house of cards as customers wonder if their funds are still safe on crypto platforms.

As a result, Binance, Crypto.com, and many others have since promised to provide proof of reserves as reassurance. While such verification is a step forward, is it a move that is too little and too late to win back our confidence in crypto?

Proof of reserves, is that enough?

With crypto exchanges under intense scrutiny to reassure customers that their business is solvent, offering customers a “proof of reserves” has since emerged as the antidote to the poison seeping through the industry. 

In short, firms would subject themselves to an independent, third-party audit to demonstrate that they have sufficient funds to cover deposits and withdrawals.

binance ceo twitter
Following CEO Changpeng Zhao’s call for transparency, Binance has appointed the accounting firm Mazars to verify its reserves / Image Credit: CZ Zhao via Twitter

Although this is an encouraging step, there are still limitations to a reserves audit since it omits hidden liabilities or creditor claims to digital assets. 

According to Deniz Appelbaum, an assistant professor of accounting and finance at Montclair State University, proof of reserves — far from being a full audit — only offers a glimpse into the big picture.  

“Investors might assume that this attestation is similar to a full audit when in reality it is not complete and does not disclose the full assets or liabilities,” he said.

Industry insiders have also expressed cynicism and doubt about using proof of reserves to imply solvency or as a solution to safeguard funds.

kraken CEO twitter
Jesse Powell, CEO, and co-founder of US-based exchange Kraken have called the proof of reserves practice outright pointless in a tweet / Image Credit: Jesse Powell via Twitter

In addition, proof of reserves reflects the reserves at a point in time. This means exchanges can move their funds elsewhere once the audit is over.

Now, considering how FTX claimed to have undergone audits, it would seem that even with due diligence, investors are still none the wiser about the trustworthiness of a company.

Restoring trust in crypto

FTX sam bankman-fried
Once the golden boy of crypto and ethical business, Sam Bankman-Fried has singlehandedly brought down FTX, along with the trust we have in the industry / Image Credit: Bloomberg

There have always been doubts about the crypto industry, with some calling it a giant Ponzi scheme.

Despite this, interest in crypto continued to grow. Amateurs and seasoned investors alike were all hoping to gain a slice of its seemingly boundless wealth.

In the good times, there was trust as long as profits flowed in. But following a torrid year of shocks, scandals and bankruptcies, confidence in crypto exchanges has probably hit rock bottom.

While offering proof of reserves is a step in the right direction, better oversight from regulators and industry stakeholders will be needed to salvage the remnants of crypto.

There is no better time than now for governments to enact regulations for the crypto industry and provide more stability to a notoriously volatile industry.

After all, 2022 has shown us that digital currencies are not the problem. Human error and mismanagement arising from a complete lack of guidance, ethics and regulations have been the cause behind many crypto firms going awry.

To the crypto purists who are against regulations because it goes against its ethos of decentralisation, even they will have to admit to this. Crypto has grown beyond its original idea and is no longer that inclusive financial system for people, by people.

Moreover, in the wake of the current crypto maelstrom, laws, policies, and regulatory measures to make the crypto markets and ecosystem safer are what the industry needs.

Only then will investors return with renewed confidence, knowing they are not throwing their hard-earned cash into the black hole of blockchain.

Featured Image Credit: The Economic Times