Crypto isn’t as transparent as it claims

A common theme in the liquidity crunches that struck crypto firm after crypto firm this year is allegations — often later substantiated — that they mishandled customer funds. Even if they hadn’t, how would they prove they were above board? That lack of transparency has only fueled the bank-run-like behavior of crypto customers. With Celsius and Voyager Digital’s bankruptcies fresh in their minds, FTX customers piled on the withdrawal orders before it, too, filed for Chapter 11.

In the case of FTX, suspicions were well-founded: Despite CEO Sam Bankman-Fried’s claims otherwise, his firm lent out more than half of customer assets — up to $10 billion — to Alameda Research, the investment firm he also controlled, according to The Wall Street Journal.

To save crypto, the industry’s turning to the blockchain. A number of crypto exchanges are pledging to publish “proof of reserves,” blockchain-based evidence that they actually hold the assets they claim.

• Why doesn’t this already exist? That’s a fair question, and the lack of answers shows the opaque business practices that have sprung up around crypto. Think hedge funds but with even less regulation. It took the collapse of one of the world’s largest exchanges to force a rethink.
• “We need consumers to have more trust in crypto in order to drive more mainstream adoption,” said Jason Baptiste, CEO and co-founder of crypto app YDY. “Proof of reserves does this.”
• After CEO Changpeng “CZ” Zhao pledged to publish Binance’s reserves, the exchange put up a page on its website that links to various crypto wallets it claims to control. Binance says it has $2.2 billion in bitcoin and $2.5 billion in ether, among other tokens.
• OKX and Huobi also said they’d publish proof of reserves.

Transparency is just a stopgap. This type of transparency is a good step by the industry to demonstrate security and solvency, said Michael Fasanello, crypto compliance officer at Anchain.AI, but ultimately regulation is necessary to ensure safety and security of assets, he added.

• Congress is considering bills to regulate crypto, but none are close to passage. The EU’s MiCA rules are expected to roll out in 2024. Until those arrive, the industry will have to come up with its own measures, including proof of reserves or a self-regulatory organization like FINRA, to provide peace of mind to consumers and investors, Fasanello said.

• There is no standard for what or how companies should publish, which is a problem, said Denelle Dixon, CEO and executive director of the Stellar Development Foundation: “Simply publishing documents without consistent standards doesn’t help the investing public much.”

• Coinbase argued in a blog post that there can’t be a bank run at Coinbase because it keeps all its customer funds secure and does not trade or use customer assets without their consent. “As you can review in our publicly filed, audited financial statements, we hold customer assets 1:1. Any institutional lending activity at Coinbase is at the discretion of the customer and backed by collateral,” wrote CFO Alesia Haas.