Binance’s proof-of-reserves raises red flags: Report

Corporate structure, Bitcoin liabilities and internal control quality are among the points of concern.

Binance’s efforts to improve transparency of its reserves also exposed red flags in the crypto exchange’s finances, according to accounting and financial specialists consulted by The Wall Street Journal. 

As noted by a former Financial Accounting Standards Board (FASB) member and investment manager, the report released by the audit firm Mazars does not bring investors confidence about the exchange’s finance as it lacks information related to the quality of internal controls and how its systems liquidate assets to cover margin loans.

Another red flag raised by the newspaper’s sources is regarding the lack of information about Binance’s corporate structure. As per the report, Binance’s chief strategy officer, Patrick Hillmann, was unable to provide the name of Binance’s parent company since it has been going through a corporate reorganization for almost two years.

Differences between the total Bitcoin liabilities were also highlighted. The exchange’s proof-of-reserves shows that Binance was 97% collateralized if excluded assets lended to users through loans or margin accounts, indicating that the 1:1 ratio of reserves to customer assets was not achieved. Mazars’ letter states about the difference:

“We found that Binance was 97% collateralized without taking into account the Out-Of-Scope Assets pledged by customers as collateral for the In-Scope-Assets lent through the margin and loans service offering resulting in negative balances on the Customer Liability Report. With the inclusion of In-Scope Assets lent to customers through margin and loans which are overcollateralized by Out-Of-Scope Assets, we found that Binance was 101% collateralized.”

John Reed Stark, Senior Lecturing Fellow at Duke University School of Law and former chief at Office of Internet Enforcement for the Securities Exchange Commission (SEC), stated in a Twitter post about Binance’s reserves:

“Binance’s “proof of reserve” report doesn’t address effectiveness of internal financial controls, doesn’t express an opinion or assurance conclusion and doesn’t vouch for the numbers. I worked at SEC Enforcement for 18+ yrs. This is how I define red flag.”

Following FTX collapse, Binance released last month a proof-of-reserves system that allows users to verify their assets using a Merkle tree. The initiative, however, was labeled “pointless” by rivals as it failed to include liabilities. 

Mazars disclosed its audit report on Binance’s Bitcoin reserves on Dec. 7. According to the international audit company, the crypto exchange possesses control over 575,742.42 Bitcoin of its customers, worth $9.7 billion at the time of the report. Per the methodology, “Binance was 101% collateralized”, said the company.

The scope of the report included customers’ spot, options, margin, futures, funding, loan and earn accounts for Bitcoin and wrapped Bitcoin (WBTC). Aside from the Bitcoin network, BTC wrapped on Ethereum, BNB Chain and BNB Smart Chain were also included in the inquiry, Cointelegraph reported.