Shortly after last month's FTX bankruptcy, the world's largest crypto exchange, Binance, announced its Proof-of-Reserves scheme.
As a result, the well-known international auditing company Mazars published its first report last Wednesday. However, the five-page report raised questions.
Mazars publishes report
Last month, shortly after the FTX bankruptcy, Binance released details of its internal wallet addresses and hired an outside auditing firm to prepare a report on the trading platform's reserves. "It's important for us to show customers that our coffers aren't empty, as has been observed with FTX," Binance Chief Strategy Officer Patrick Hillman told The Wall Street Journal.
Binance is not required to submit audited financial statements to the authorities as a private company. On the other hand, public crypto companies like the trading platform Coinbase have to submit essential company data to the US Securities and Exchange Commission (SEC). A Proof-of-Reserves system was critical for Binance to calm its clients and the crypto environment.
However, Mazars' report provided little insight into the company's business structure. On the paper's last page, you can only find a short section called "Report Details," which lists three Binance business figures. One was called "customer deposit liabilities," reported as 597,602 bitcoin. The second number, titled "Net Assets Report," showed that the crypto exchange owns 582,486 bitcoins on the assets side.
As a result, the bitcoin liabilities cited in Mazars' letter are 3% higher than the company's bitcoin assets. Binance's bitcoin assets were only 97% covered when writing the report (November 22). According to Wall Street Journal calculations, the firm owned $9.43 billion worth of Bitcoin at the time, while liabilities were the equivalent of $9.68 billion.
The third figure in the report paints a different picture of Binance's reserves, listed as "Net Liability," indicated liabilities from customer deposits, revised down 21,860 bitcoins to 575,742 bitcoins.
A company spokeswoman, Jessica Jung, explained that the difference of 21,860 bitcoins is because "customers of the platform can get bitcoin loans through the lending program." The prerequisite for this is that the customers deposit a Security on Binance. In addition to Bitcoin, users can employ various Altcoins as an alternative to BTC. The exchange quoted the value of the altcoin collateral in bitcoin, which is why actual bitcoin liabilities are lower. On that adjusted basis, the Mazars report showed liabilities were 1% less than assets, leading Mazars to state that "Binance was 101% collateralized."
Although Binance's reserves are fully funded, according to Mazars, the report raised a few questions. Mazars did not provide any comment or conclusion at the end of the information, meaning the company does not guarantee the numbers. Likewise, the report did not address Binance's internal financial controls. John Reed Stark, who worked at the SEC for more than 18 years, called this a red flag:
"Binance's PoR report does not deal with the efficacy of internal financial controls, provides no opinion or conclusion, and does not guarantee the report's numbers. I worked for SEC Enforcement for over 18 years. This is how I define a red flag." John Reed Stark
More doubts emerged with the correspondence to Binance Capital Management Co. Ltd., based in the British Virgin Islands. The report did not indicate whether the audited assets were held by Binance Capital Management Co. Ltd. or managed by another company in the group. Hillmann even stated that he could not name Binance's ultimate parent company as the company has been undergoing major corporate restructuring recently.
In addition, the report needs to provide information on Binance's financial situation. They did not disclose the other crypto reserves' assets or total liabilities. The report was only limited to the company's bitcoin reserves. While Binance said it would release information about the company's crypto reserves in the coming weeks, the company did not explain the reasons for this strange gradual disclosure.
Due to the reserved information, the question arose whether the exam could be called an exam. Carmichael, the former chief auditor of the Public Company Accounting Oversight Board (PCAOB), told the Wall Street Journal that calling the report an audit was a gross misrepresentation.