Regulator Warns Crypto Investors Against “Proof Of Reserve” Reports, Says Can’t Be Trusted

The US Securities and Exchange Commission (SEC) has warned cryptocurrency investors about the reliability of “proof of reserve” reports. According to the regulator, these reports cannot be trusted as they are often inaccurate or misleading. This warning comes as more cryptocurrency companies are claiming to have external audits and provide proof of reserves to gain investors’ trust. However, the SEC advises investors to conduct their own due diligence before investing in any cryptocurrency. The agency also reminds investors that digital tokens are not the same as stocks and that their valuations may be volatile and speculative.

The involvement of regulators in the crypto industry may sometimes seem unnecessary or threatening, but it is important to note that not all regulators have malicious intentions—some are committed to safeguarding consumers. On March 10th, the Public Company Accounting Oversight Board (PCAOB), a watchdog organization funded by the industry and operating under the Securities and Exchange Commission (SEC), released an advisory report regarding “Proof of Reserve” reports that certain crypto firms show their customers to demonstrate solvency.

Proof of Reserve (PoR) is a type of report used by various industry firms, such as crypto-exchanges and stablecoin issuers, over the last few months to promote their protection against bank runs. Although crypto firms have claimed these reports are sufficient proof that they are well-funded, the PCAOB has stated otherwise. The organization’s statement on March 8th explains that these reports do not provide any “meaningful assurance” to investors or the public because they are “not audits” and do not comply with any particular standard.

Proof of Reserves can also be interpreted as a way of demonstrating verification of a company’s assets, such as those held by a crypto-exchange. Assets’ verification is recorded by taking a snapshot of all sums of particular crypto assets on the exchange. However, the PCAOB report claims that this method of verification is inadequate to demonstrate an exchange’s health because the procedures do not consider the digital asset holders’ rights and obligations or the crypto entity’s liabilities. It also does not address whether the assets have been borrowed by the crypto-entity to appear that it has adequate collateral or “reserves” beyond customer demands. The Board also added that PoR does not assure “the effectiveness of internal controls or governance” of the crypto firm. The Board similarly cautioned investors, stating that “Proof of reserve reports are inherently limited, and customers should exercise extreme caution when relying on them to conclude that there are sufficient assets to meet customer liabilities.”

The FTX downfall had a lot of negative repercussions on the industry, including the loss of trust among the crypto community. Nevertheless, many firms strived to get trust back, one of which was Binance, one of the crypto sector’s biggest firms. They began publishing proof of reserve reports, which it touted as a form of “liquidity transparency” and proof that the company was fully solvent. Other crypto firms such as Kraken, Bitget, and followed Binance’s lead and published their respective proof of reserves. 

Although some crypto firms have taken proactive measures to restore the crypto industry’s image, the crypto market is still in a slump. As of now, the global crypto market capitalization is down 1.2%, with larger assets such as Bitcoin and Ethereum plummeting 8.1% and 7.5% respectively over the past seven days.

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