January 25, 2023

After the collapse of FTX, Binance has been at the center of all the controversy surrounding the introduction of a Proof of Reserves.

After the bankruptcy of FTX, almost all major crypto exchanges have started providing a so-called proof that they are not speculating with their clients’ funds and are holding them completely.

Since there is no industry-wide standard for Proof of Reserves (PoR) yet, the community is very critical of the exchanges’ approach. And Changpeng Zhao’s Binance and its latest HbR top the list, of course.

The Wall Street Journal recently published a report that hits Binance hard. The exchange hired an outside accounting firm to prepare a “proof-of-reserve report” covering some of its assets and liabilities.

However, as the crypto community discovered, this is an “agreed on procedures engagement” (AUP), which is “not an audit, review, or assurance engagement,” according to the accounting firm.

New report raises questions about Binance’s accounting

The latest report of the WSJ also focuses on this. It warns that investors should not be satisfied with the report. Douglas Carmichael, an accounting professor at New York’s Baruch College and former chief auditor of the US Public Company Accounting Oversight Board explained:

I can’t imagine it answers all the questions an investor would have about collateral adequacy. That’s the main thing it seems to speak against.

As the report notes, Binance is a private company that is not required to provide audited financial statements and has never done so.

Another red flag, the report says, is that Binance Chief Strategy Officer Patrick Hillmann was unable to name Binance’s parent company, as Binance has been “undergoing corporate restructuring for nearly two years.”

The PoR report is a five-page letter from a partner at the South African subsidiary of global accounting firm Mazars and contains three figures. However, these raise even more questions.

While the “customer liability report” figure was 597,602 bitcoins, Binance puts its “asset balance report” at 582,486 bitcoins. The difference apparently means that Binance does not meet the 1:1 ratio of reserves to customer assets:

As a result, the total bitcoin liabilities mentioned in the Mazars letter were 3% larger than the bitcoin assets included in the scope of the report as of the reporting date, which was Nov. 22.

101% collateral?

The third figure “net liability balance (excluding assets lent to customers) paints a different picture. It shows a liability figure that has been revised down by approximately 21,860 BTC to 575,742 BTC.

The justification for this is client crypto assets lent through loans or margin accounts, leading Mazar to conclude that Binance had “101% collateral when the methodology was applied.”

Hal Schroeder, a former member of the Financial Accounting Standards Board (FASB), pointed to another problem. According to him, the Mazars report lacks meaning because it contains no information about the quality of Binance’s internal controls:

We don’t know how good Binance’s systems are at liquidating assets to cover any margin lending. And we know that banks in the US are occasionally caught off guard, despite all the good systems out there.

Given what we’ve seen in the Bahamas, I don’t want to conclude that all systems are that good.

At the time of writing, the price of BNB was $283.80.

Binance BNB USD 2022-12-12
BNB price, 4 hours chart. Source: TradingView

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