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Crypto audits are a practice of faith, less math

Crypto audits are coming back in style, but it’s still a voluntary practice akin to paint-by-numbers — and without all the numbers. Call it a trust exercise.

Why it matters: This voluntary math goes through cycles of popularity (usually after something goes wrong) and has regained importance after two major crypto lenders – Celsius Network and Voyager Digital – filed for bankruptcy reorganization. But they are not Perfect.

  • Proof of reserves, or “PoR” is only part of the proof equation ability to pay, Saravanan Vijayakumaran, associate professor at the Indian Institute of Technology Bombay, tells Axios. “To answer your question regarding [the audits] be holistic – they are not holistic.”

details: Crypto audits ideally show that cryptos held on deposit match customer account balances, but to complete the equation for proof of solvency one would need to provide proof of this Liabilities, in addition to custodians certifying the reserves held.

  • In order to calculate the total liabilities of a cryptocurrency exchange, private, internal customer databases would have to be handed over.

Threat Level: Voluntary audits could also mean hidden Liabilities and imperfect implementations.

Push the news: Exchange operator Kraken completed the second of its PoR audits last week. It also expanded the assets only covered by Bitcoin and Eth to include USDC, USDT, DOT, ADA and XRP.

  • The billing process cryptographically verifies crypto holdings and account balances; an accounting firm, Armanino LLP, checks this.
  • Kraken’s PoR audit also allows it Customers to check the results.

details: Other companies that have conducted PoR audits in the last 24 months, according to Nic Carter, general partner at Castle Island Ventures, who is urging the industry for regular audits:

  • The crypto platform Nexo performs authentications in real time.
  • Coinfloor and BitMex conducted self-assessments.
  • Ledn has a semi-annual, user-based validation approach.

What you say: “Our regular Proof-of-Reserves audits demonstrate Kraken’s ability to create a higher standard of accountability and transparency — not just in the crypto space, but in the broader banking and finance space,” Kraken said in a blog post on Thursday.

Yes but: Krakens expanded The voluntary audit still only covers 63% of the total assets of the company. A spokesman tells Axios that the company will add assets for future audits.

  • When asked about the decision to expand the assets under review, Kraken spokeswoman Edith Camargo said, “Kraken has always had intentions to expand the set of assets covered beyond Bitcoin and Ethereum. With these new assets, we are now able to verify seven of the top 10 coins by market cap.” (Solana is excluded)
  • The company started cryptographic PoR audits earlier this year.

The big picture: “[The] the industry does not seem to want this,” says Prof. Vijayakumaran. “Eli Ben-Sasson, founder of StarkWare, says that exchanges were not interested when StarkWare offered to provide proof of solvency.”

  • “The technical complexity seemed to be an obstacle,” he adds. “When Kraken CEO Jesse Powell was informed of commissions (Stanford Group Proof of Solvency), he stung on it.” (That was all in February 2020)
  • Lack of support for all bitcoin address types and technical complexity were the reasons for the kahn, says Prof Vijayakumaran, but Kraken has since started PoR certifications with an independent auditor.

flashback: Mt. Gox, the legendary exchange that was once responsible for 70% of the world’s bitcoin transactions, declared bankruptcy in February 2014.

  • The crypto industry says that PoR certificates could have uncovered long-term bankruptcies like that of Mt. Gox and the like.
  • As part of a calming effort, a handful of executives, including the CEOs of Kraken, Bitstamp.net, BTC China, Blockchain.info, and Circle, signed a letter admonishing the exchange for failing to meet “essential requirements as a financial services provider.”

The final result: “To those who oppose PoR because it is not entirely trustworthy in its current implementation, I would answer that the perfect is the enemy of the good. Currently, the industry standard is virtually no transparency,” wrote Carter of Castle Island Venture.

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