So, now that everyone has watched in real-time, the downfall of SBF, FTX and Alameda Research, every other major centralised exchange has been frantically trying to prove its solvency. How do you prove such a thing?
Well, the current method being deployed is by doing what is called, ‘proof-of-reserve’ — basically a statement of what they have in liquid reserves, as far as cryptocurrency is concerned. The first to do this was Binance (see here):
A company called Nansen Portfolio was able to create a real-time version (see here) of this for Binance, which I have screenshotted below (13th Nov.):
Now, $70B in reserves is nothing to be sniffed at, but what of the other exchanges?
An industrious member of crypto-twitter (see tweet here) has also compiled a token holder pie chart to demonstrate the same basic issue (Exchanges holding enormous quantities of their own coin):
BITFINEX LEO TOKEN:
Proof-of-reserve is a very healthy step for the crypto sphere as a whole, as I think we can all agree that more transparency is most certainly a good thing for the industry.
So what do I mean by the Domino Effect?
Well, aside from the unfathomable greed, mismanagement and stupidity demonstrated by FTX and Alameda, their death was based on one key flaw: Their self-issued coin FTT. This coin, which made up almost all their collateral and a huge portion of their capital reserves, was essentially what was propping them up after their enormous trading losses. So, when Binance publically sold their huge holdings of the said coin, and thus began a sell-off, their house of cards crumbled faster than you can say insolvent.
The Domino Effect comes into question when you analyse the proof-of-reserves of the other big exchanges. How much of their own coin do they hold?
Well, in the case of Binance, you can see that basically 40% of their reserves are made up of their stablecoin BUSD and their BNB token. That seems like a very large portion. Remember how fast Terra and Luna collapsed when their ‘stable’ coin depegged? If for some reason, BUSD was to depeg, Binance might be in deep shit. This is mirrored by Bitfinex, who have 30% of their reserves in their native coin LEO.
I suppose, if I was offered the chance to create my own currency, knowing that when that currency takes off, even a little, my enormous stash I keep for myself will inflate the value of my company and my leveraging capabilities ten-fold, I’d do the same. But what happens when the price collapses?
Well, as Jeremy Irons so famously said in Margin Call:
[you’re] going to be left holding the biggest bag of odorous excrement ever assembled in the history of capitalism.
And that's exactly what is going to happen with centralised exchanges if things get even a tiny bit worse. It's not macro economics they need to worry about, it's not even micro economics, it’s customer trust.
This is a similar theme when looking at Kucoin, which has 16% of its reserves in its native token. But then we get to Crypto.com, which I was expecting to be basically 100% CRO (their token), but amazingly, this huge exchange has…. 20% of its reserves in SHIBA. You really couldn't make this up. They have $540 MILLION in Shiba. SHIBA, is, let's not forget, an ironic duplication of DogeCoin. A dog-based meme coin. That's like going to the Federal Reserve and seeing that 20% of their reserve is made up of ingots of scrap metal. So what exactly would happen if say, there was a crash in the price of SHIBA? Exactly.
But wait, the plot thickens:
This morning I saw the news that Crypto.com had erroneously sent Huobi a large quantity of ETH. This is being alleged (see tweet) to have not been accidental, but for the purpose of bolstering Huobi’s own proof-of-reserves.
Kris, the CEO of Crypto.com came out and said this in response (see here):
So, nothing to worry about then, Kris?
The issue, if this was not true, is how it even came to happen. As Kris claims above, it was nothing to worry about, and, that those reserves were recovered and put back into cold storage. RIGHT. So, they lept out of cold storage on their own? The fact that this was even physically possible should cast huge doubts over the safety of their user's deposits. Imagine you gave your friend a bar of gold to keep in their safe. You then see your bar of gold in the safe of his neighbour and your friend says, “don’t worry, it was an accident, it's back in my safe again — nothing to see here”. You’d take your gold back immediately.
There is a real threat that a lack of customer trust could bring a bank run on some of these exchanges. I have seen comments online of people suggesting the community should unite in a once-a-month mass withdrawal from each exchange to see if ‘they have their hand in the cookie jar’. A noble idea, but I think that we all now know most of them in fact do and are partly propped up by the over-inflated value of their own shit-coin. My money would be on Crypto.com being the next domino to fall, but not the last.