Despite seeming acceptance, crypto analyst Martin Hiesboeck argues that PoR (PoR) is used to demonstrate its transparency and reassure nervous users. He added that PoR alone is not a good way to validate an exchange’s reserves, as it “doesn’t consider any liabilities or off-chain assets.”
PoR could be ‘misleading and deceptive’
Confidence in centralized exchanges declined after the collapse of FTX in November. , many users are rushing to move their assets from such platforms. This has accelerated the movement of cryptocurrency exchanges to offer or publish Proof of Reserves (PoRs).
Seen as an emergency response to the confidence crisis caused by the fall of FTX, the PoR Merkle Tree has become the de facto standard used to predict transparency on cryptocurrency exchanges. It seems to have worked. Proponents of PoR claim that using this auditing method reassures users that the crypto exchange is not misusing their funds.
However, despite its apparent acceptance by many in the crypto industry, simply presenting a PoR audit cannot prove that an exchange is not misusing customer funds. There is a possibility. It is also alleged that some cryptocurrency exchanges have lent funds to each other just prior to the audit and returned these shortly after the PoR was presented.
For critics like Martin Hiesboeck, cryptocurrency analyst and head of blockchain and cryptocurrency research at multi-asset digital trading platform Uphold, PoR Not a proper tool for proving exchange status. Because they “do not consider liabilities and off-chain assets at all.” According to Hiesboeck, this makes his PoR “incomplete at best and misleading and deceptive at worst.”
As to why parts of the crypto space seem to support his PoR, Hiesboeck told his Bitcoin.com News:
It has shaken confidence in centralized exchanges. CEX [centralized exchange] needed a quick and public “emergency response” to restore public and user confidence…at least on paper.
Nonetheless, Hiesboeck says PoR has two problems, making him susceptible to manipulation and misrepresentation. One is what Hiesboeck describes as the inherent opacity of Markle’s Tree of His model. A model by this design “allows verification of specific data without revealing its contents.”
For centralized exchanges using this model, it means that their respective auditors can publish a “legitimate snapshot” of the crypto exchange platform’s reserves. Explaining why this is a problem, Heathbeck said:
Ordinary bystanders have no means of verifying PoR results, nor a guarantee that no funds have been moved from these addresses immediately following an audit. Solving this problem, at least in part, requires some sort of real-time, independent reserves monitoring system that provides up-to-date information over time.
Exclusion of exchange outstanding debt in PoRs is another issue that reduces credibility as a way of verifying or confirming the financial health of crypto exchange platforms. Therefore, presenting or exposing the assets of a cryptocurrency exchange without disclosing its liabilities does not provide an accurate picture of the platform’s financial health, Heathbeck argued.
“Many exchanges that publish PoRs do not include such information, making it less transparent. nor does it reflect the
Yet, despite the arguments of his Hiesboeck and other critics against the use of this model, PoR seems to be gaining momentum. As reported by Bitcoin.com News, several large cryptocurrency exchanges have presented audits based on the Merkle Tree model. Binance, one of the world’s largest crypto exchange platforms, recently published his PoR of Bitcoin. The snapshot suggested that BTC reserves on Binance were slightly higher than net user balances.
On the other hand, when asked if there were better alternative verification methods, Heathbeck replied:
that the entity is located in the appropriate jurisdiction; and proof that all certifications have been reviewed by an external audit firm.
Image CreditsShutterstock, Pixabay, Wiki Commons, Dr. Martin Hiesboeck, Twitter