Crypto Exchanges Scramble to Compile 'Proof-of-Reserves' as FTX Contagion Grips Markets

Crypto exchanges are now scrambling to publicly publish their fund reserves as insolvency fears grapple crypto investors following contagion risks from liquidity issues at FTX.

In the past 24 hours, seven exchanges – Binance, Gate.io, KuCoin, Poloniex, Bitget, Huobi and OKX – have separately issued statements that they would publish their Merkle tree reserve certificates to increase transparency.

Binance and KuCoin did not return requests for comments regarding the one-month period, which may be considered long given current conditions, at writing time.

A Merkle tree is a data structure that is used in computer science applications. In bitcoin (BTC) and other cryptocurrencies​, Merkle trees serve to encode blockchain data more efficiently and securely. They are also referred to as "binary hash trees."

In a centralized crypto exchange, every user’s assets are recorded by the ledger of a centralized database. The recorded assets in the database are the total amount of the user’s assets.

Using Merkle trees allows exchanges to store each user account’s hash value of assets in the “leaf nodes” of the Merkle tree. The second step is to audit those assets in the leaf node of the Merkle tree and verify all the users’ holdings by a third party.

Crypto exchange Binance founder Changpeng "CZ" Zhao urged industry players to provide “proof-of-reserves” following yesterday’s events involving FTX and Binance. Elsewhere, crypto entrepreneur Justin Sun said Huobi, of which Sun is a stakeholder and advisor, would conduct "a third" Merkle tree reserve test.

All crypto exchanges should do merkle-tree proof-of-reserves.

Banks run on fractional reserves.
Crypto exchanges should not.@Binance will start to do proof-of-reserves soon. Full transparency.

— CZ 🔶 Binance (@cz_binance) November 8, 2022

FTX came under scrutiny following a CoinDesk report last week that found the balance sheet of Alameda Research, a crypto trading unit owned by Sam Bankman-Fried, who also owns FTX, was full of FTX’s native FTT tokens. This meant that Alameda rested on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto.

The report sparked rumors of FTX becoming possibly insolvent, which in turn led to industry players selling FTX-linked coins to protect their own downside. Rival Binance, which held over $500 million of FTT on its books, started to offload its holdings – which culminated in a 24-hour-long drama that ended with Binance signing an intent to acquire FTX, which is now considered by many to be insolvent.

Stablecoin issuer Circle, which counts FTX as an investor, played down its exposure to the troubled exchange along with rival Tether and crypto exchange Coinbase.

Read more: FTX Agrees to Sell Itself to Rival Binance Amid Liquidity Scare at Crypto Exchange