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Binance Calling Proof Reserves An “Audit” Is A “Gross Misrepresentation,” says expert

The world’s largest cryptocurrency exchange is seeking to reassure customers, but auditing experts and financial specialists are not buying it. 

Binance has started publishing data in order to improve trust after the FTX collapse, reports The Wall Street Journal.  The cryptocurrency exchanges made the move  just a few weeks after Changpeng Zhao (CZ)  had come to a strategic agreement with Sam Bankman-Fried about purchasing FTX. That deal fell apart after CZ reviewed FTX’s balance sheet. FTX filed for bankruptcy November 11, leaving potentially one million customers and other investors facing total losses of billions of dollars.   

“It’s important for us to show users that the coffers are not bare, like at FTX,” said Binance’s chief strategy officer, Patrick Hillmann. 

On November 25, Binance announced its new “proof of reserves system” and referred to numbers “as audit results.” Mr. Carmichael, the former PCAOB chief auditor, said: “It is a gross misrepresentation to call this an audit.”

Much basic information about Binance remains unknown. For instance, Mr. Hillmann wouldn’t provide the name of Binance’s parent company. To Hal Schroeder, a former Financial Accounting Standards Board member and investment manager who teaches accounting at Rutgers University, the Mazars report means next to nothing due to lack of information about the quality of Binance’s internal controls, like its systems for keeping accurate books and records. 

“We don’t know how good Binance’s systems are to liquidate assets to cover any margin loans,” he said. “And we know in the U.S., even with all the good systems, banks have occasionally been caught off-guard. In light of what we’ve seen in the Bahamas, I don’t want to conclude that all the systems are that good.” 

Binance’s so-called “commitment to transparency” isn’t likely to disclose any meaningful information, according to accounting and financial specialists. In the past month, Binance has publicized details about its crypto wallets, hired an outside accounting firm to prepare a “proof reserve report,” and promised more information in the future. 

“When we say proof of reserves, we are specifically referring to those assets that we hold in custody for users,” Binance says on its website. “This means that we are showing evidence and proof that Binance has funds that cover all of our users assets 1:1, as well as some reserves.” 

The report should not go so far as to satisfy investors, according to Douglas Carmichael, an accounting professor at Baruch College in New York and former chief auditor of the U.S. Public Company Accounting Oversight Board. 

“I can’t imagine it answers all the questions an investor would have about the sufficiency of collateralization,” Mr. Carmichael said. “That’s the main thing it seems to speak to.”

The report, released Wednesday, is nothing more than a five-page letter from a South African partner at the global accounting firm Mazars. Not an audit report, the letter didn’t address the effectiveness of the company’s internal controls, and noted that Mazars did  “not express an opinion or an assurance conclusion.”

Addressed to a Binance entity called Binance Capital Management Co. Ltd., based in the British Virgin Islands and not likely to be the parent company of Binance, the report, with a scope limited to bitcoin-based assets and liabilities, did not reveal total assets or total liabilities. 

Binance promised more information over the coming weeks about other crypto tokens. “This is the first step in what’s going to be a much longer process,” he said. The Mazars partner who wrote the letter, Wiehann Olivier, declined to comment.

On the last page of the Mazars letter was a brief section called “report details,” which consisted of the three numbers, each denominated in bitcoin. One number was labeled “customer liability report balance” and showed a balance of 597,602 bitcoins. Another number, labeled “asset balance report,” showed a balance of 582,486 bitcoins. 

The total bitcoin liabilities cited in the Mazars letter were 3% greater than the bitcoin assets included in the report as of Nov. 22. 

In U.S. dollar terms, based on bitcoin’s price at the time, the liabilities would have been about $9.68 billion, while the assets would have been $9.43 billion, or about $245 million smaller, according to The Wall Street Journal.

The third number, “net liability balance (excluding in-scope assets lent to customers)” shows a liability figure adjusted down by approximately 21,860 bitcoins to 575,742 bitcoins. Binance noted it lets customers borrow crypto assets through loans or margin accounts. 

This adjusted basis, according to Mazars, means the liabilities were 1% less than the assets. “Binance was 101% collateralized,” wrote the auditing firm.  When using a larger liabilities number for the calculation, Binance was 97% collateralized. 

Binance spokeswoman Jessica Jung said the 21,860 bitcoin difference was “made up of BTC loans made to customers through the Binance loan program,” continuing that “the collateral for said loans are not in BTC, but in other currencies.”

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