Trust Crisis - How far will the Centralized Exchanges Transparency Go?

Updated November 15, Huobi's reserve data added.

Updated November 23, Phemex reached out to us for an update on their progress.

With the successive bankruptcies of Alameda Research and FTX, SBF's Crypto empire collapsed in just one week. This was a huge blow to the entire Crypto market, which plummeted from $1,000 billion to $870 billion in market cap, and saw the price of Bitcoin and Ethereum fall to $16,000 and $1,200 respectively, a 7-day drop of over 20% according to TokenInsight.

Due to the misappropriation of user funds by FTX, transparency of reserve assets on centralized exchanges has become a key concern for every exchange user. CZ, the CEO of Binance, made this point on November 9. The next day Binance completed the disclosure of on-chain addresses of mainstream assets in its reserve. What about other exchanges? We have filtered the Top15 centralized exchanges by TokenInsight exchange ratings and trading volume. And we want to provide a brief overview of the topic based on publicly available information.

Disclosure of Exchange Reserve Assets

• Binance has published the addresses of the mainstream assets in its reserves. Binance Blog
• OKX has published the addresses of the mainstream assets in its reserves. Twitter@okx
• Kucoin has published the addresses of the mainstream assets in its reserves. Kucoin Blog
• Gate.io has invited Armanino to conduct a Proof of Reserve audit of its reserves, and its Bitcoin and Ethereum reserves exceed liabilities. Armanino TrustExplorer
• Crypto.com has published the addresses of Bitcoin and Ethereum in its reserves. Twitter@kris
• Bybit has not yet released the address of the reserve assets or Proof of Reserve audit report, stating that it is preparing for the audit and the expected completion date has not been announced. Twitter@benbybit
• Huobi has published the addresses of the mainstream assets in its reserves. Huobi Support
• Deribit has published the addresses of Bitcoin and Ethereum in its reserves. Deribit Blog
• BitMEX developed the Proof of Reserve tool in the summer of 2021, which allows users to check the balance of their Bitcoin reserve assets at any time. BitMEX Blog
• Bitfinex has published the addresses of the mainstream assets in its reserves. Bitfinex Blog
• Kraken has been audited by Armanino on a quarterly basis since 2014 for Proof of Reserve. Kraken Blog
• Phemex has not yet released the address of the reserve assets or Proof of Reserve audit report, stating that it is preparing for the audit and expects to be finished within 30 days. Twitter@Phemex_official

Phemex published the Proof of Reserve audit on November 23rd. Now users can check the information about $BTC, $ETH, $USDT, $USDC, and $USD balances in their accounts on the Phemex official website, data based on November 20th.

• MEXC Global has not yet released the address of the reserve assets or Proof of Reserve audit report, stating that it is preparing for the audit and the expected completion date has not been announced. Twitter@MEXC_Global
• Bitget has not yet released the address of the reserve assets or Proof of Reserve audit report, stating that it is preparing for the audit and expects to be finished within 1 month. Twitter@BracyBitget
• AAX has not yet released the address of the reserve assets or Proof of Reserve audit report, stating that it is preparing for the audit and the expected completion date has not been announced. Twitter@AAXExchange

*Coinbase、Binance.US、FTX.US are regulated in the United States and are not included in this review.

Statistics as of November 13, 2022, 12:00 UTC+8

As we can see, 10 of the Top15 CEXs have already disclosed the wallet addresses of their main reserve assets or published Proof of Reserve reports audited by third-party institutions. While other exchanges are preparing to conduct audits as well. In addition, 6 exchanges - Binance, OKX, Crypto.com, Kucoin, Deribit, and Bitfinex - have partnered with Nansen to launch their reserve dashboard. Still, more exchanges are in the pipeline, and the number of institutions showcased on this dashboard will continue to grow in the future.

It is worth noting that while the disclosure of the reserve wallet address only proves the assets of the exchange, a Proof of Reserve audit contains both assets (the amount users can withdraw from the exchange) and liabilities (the amount a user has deposited to the exchange). While not as transparent as disclosing wallet addresses, the audit provides a better picture of the exchange's asset/liability ratio. There are advantages and disadvantages to both methods of disclosure, and we believe that the willingness to provide more transparent information about reserve assets to users is more important than the method.

How Much Assets Do Exchanges Have?

As far as the exchanges that have published their asset reserves are concerned, Binance has the largest, with a total of $63.8 billion. It is followed by Bitfinex ($7.8b), OKX ($5.8b), Huobi ($3.3b), KuCoin ($2.7b), Crypto.com ($2.4b), and Deribit ($1.5b).

In addition to differences in the amount of asset reserves, the composition of asset reserves varies from exchange to exchange.

How Healthy Are The Reserves?

Binance has the majority of its reserves in $BTC, $ETH, stablecoins, and its exchange token $BNB. KuCoin and OKX are in a similar situation, with $BTC, $ETH, and stablecoins accounting for the majority of their asset reserves. However, it is worth noting that OKX does not have its own platform coin $OKB in its reserve, while KuCoin exchange token $KCS has a share of 17%.

Deribit has always been focused on options derivatives trading, so its exchange reserve is basically made up of $BTC and $ETH.

For Huobi, Bitfinex, and Crypto.com, things are a little bit different. First of all, there's only 40% of $BTC, $ETH, and stablecoins in the reserve of Huobi, 28% of the exchange token $HT, and another 15% of $TRX. Crypto.com has close to 40% of its reserve in other assets than $BTC, $ETH, or stablecoins. In fact, more than half of that 40% is $SHIB, meaning that $SHIB makes up 20% of Crypto.com's asset reserve, the second largest on the exchange after $ETH.

And Bitfinex, one of the longest-running exchanges, has almost half of its reserves in $BTC, $ETH and stablecoins. But the other half (45%) of its asset reserves are in its exchange token, $LEO.

A Further Analysis

Since we are not able to access the real liabilities of exchanges, i.e., how much users actually deposit to the exchange, we chose to simulate the liabilities of the exchanges by using the number of visits and transactions. In the Visits/Reserve Assets ratio, KuCoin ranks highest with a ratio of 3.36, Crypto.com comes next with 2.02, OKX, Binance, Huobi and Bitfinex stay in the 1.09-1.39 range, and Deribit is the lowest with 0.46.

In terms of the Trading Volume/Reserve ratio, Binance has a Spot Volume/Reserve ratio of 0.29, a Derivatives Volume/Reserves ratio of 0.87, and an Overall Volume/Reserve ratio of 1.15. Using this ratio as a benchmark, we can see that KuCoin has similar patterns in these three figures. As Deribit does not offer Spot trading, the Derivatives/Reserve ratio is approximately 0.65, similar to the ratio of Binance.

The other 4 exchanges, OKX, Huobi, Crypto.com, and Bitfinex, have different patterns. OKX's overall Volume/Reserve ratio of 2.34 is significantly higher than the average, with a Derivatives Volume/Reserve ratio of 2.13, two times higher than its reserve assets. Huobi, Crypto.com, and Bitfinex, on the other hand, are significantly below average.

While we'll never know whether any exchange will be able to fully fund its users, we believe the best way to solve this problem is to increase the transparency of the exchanges as much as possible. We have analyzed the asset reserves of several exchanges above. Binance, KuCoin, OKX, Deribit, and BitMEX all have relatively comprehensive information disclosure and transparency. While Huobi's reserve of $BTC, $ETH, and stablecoins is too low (40%), Crypto.com's reserve of $SHIB is too high (20%), and Bitfinex has nearly half of its reserve in its exchange token, $LEO.

Closing Thoughts

The Crypto industry is stormy, and we have to admit that the we're still in a state of limbo. In addition to some countries and regions with some relatively basic laws and regulations, most of the world is still in the exploration stage. This exploration stage is not only troubling to industry practitioners, but also to policymakers.

At this particular time, self-regulation by companies in the industry has become a very important factor. Since Crypto exchanges are not banks, they are still required to provide 100% capital adequacy at this stage, even though the Basel III capital adequacy ratio is less than 10%. We hope that more and more exchanges will provide more transparent balance sheets and completely eliminate the misappropriation of user funds. Because only then will the confidence of users be able to grow and work together to create an environment conducive to blockchain innovation and progress.