Thursday, April 25, 2024
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Binance Withdrawal Surge Tests Proof of Reserves

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Binance (BNB-USD) is pulling ahead today. It has lost a major competitor with the FTX collapse, and Sam Bankman-Fried’s arrest has shaken investor trust in crypto. That’s not necessarily good news for Binance, as investors everywhere are looking to yank their assets off of exchanges. This means hefty outflows for the company. But, as these outflows continue, and Binance shows that it is capable of handling such drastic volume, it’s proving that it can do what FTX could not.

When FTX collapsed in November, it happened because the exchange’s assets were illiquid. FTX held just under $1 billion in liquid assets against $9 billion in liabilities. Its sibling company, Alameda Research, was secretly investing using customer funds, making these assets illiquid.

This information became public in early November, and it raised lots of eyebrows. One FTX client that took notice of this was Binance CEO Changpeng Zhao. Zhao, whose company held a significant stake in FTX Token (FTT-USD), said it would be closing the position immediately, following the breaking news. This announcement catalyzed the rush of investors from their own FTT positions, causing a bank run on FTX that it couldn’t cover fast enough due to its illiquidity.

So, in effect, Binance was able to bring down its biggest competitor with just a tweet. The company then offered to acquire FTX as the latter fell into bankruptcy. A letter of intent was signed between the two. But, the after the due-diligence check Binance required before the acquisition, it would back out of the deal. Now, investors find themselves here, with FTX in bankruptcy proceedings and its founder arrested and charged with fraud.

Binance Caused a Bank Run on FTX. Now, It Faces the Same Challenges.

Binance’s role in FTX’s demise was a crucial one. Who is to say whether or not the company is celebrating this part it had in destroying its adversary? Regardless, Binance must keep its focus as it navigates the fallout facing the whole industry amid Congress’ FTX hearing. The world’s largest crypto exchange is facing a bank run of its own. How successfully it is able to navigate this situation will prove how true to its “proof of reserves” it really is.

After FTX’s collapse, Binance announced it would be using “proof of reserves” to maintain transparency and build client trust. Proof of reserves are essentially audits the company undergoes to prove it has the funds on hand to cover any withdrawals.

This proof of reserves is meant to be a trust-building exercise to sate its existing users — who were surely worried about the exchange amid FTX’s collapse — and to woo potential new users wronged by its competitor. However, as these audits finish up, multiple red flags have been raised around the exchange. It did little to clarify Binance’s disorganized corporate structure or the quality of internal controls. The audit also forgoes an assurance conclusion, suggesting that auditors are not sure that evidence of Binance’s reserves are sufficient enough to make a firm statement on investors’ safety.

Indeed, in its attempt to assuage investors’ worries, Binance has found itself in an unsavory situation. However, it does have a chance to prove itself this week. As disgraced FTX CEO Sam Bankman-Fried is arrested on fraud charges, and Congress convenes to probe FTX creditors about the company’s collapse, crypto outflows are seeing a vast uptick.

Binance’s Handling of Outflows Will Be a Defining Moment

This week, Binance alone is seeing over $3.5 billion in outflows from its custody services. In the last 24 hours alone, the exchange has seen outflows of over $1.9 billion. Indeed, Binance’s unsatisfying audits and news of potential Department of Justice (DOJ) charges against it have shaken investor sentiment. While these outflows are not great news for Binance, they do stand to be a defining moment for the exchange going forward.

If Binance can handle this bank run, it can essentially prove to investors what its proof of reserves audit couldn’t: Binance holds enough reserves to cover any amount of investor withdrawals. This can more or less prove the company’s safety measures to protect clients’ funds. Or, of course, it can expose a lack of safety measures and cascade into another crypto exchange collapse if Binance has been lying about its fail-safes.

Not a helpful development is the fact that Binance has halted withdrawals of USD Coin (USDC-USD) from its digital trading floor this morning. Binance CEO Changpeng Zhao has pointed to an uptick in USDC withdrawals being caught in traditional bank red tape as a reason behind the pause.

Zhao says that these trades should be processed throughout the day after banks have opened up and can begin processing the conversions. It’s worth noting that in September, Binance ended trading support for USDC. It now auto-converts USDC deposits into Binance USD (BUSD-USD) for trading purposes.

On the date of publication, Brenden Rearick did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Brenden Rearick is a Financial News Writer for InvestorPlace’s Today’s Market team. He mainly covers digital assets and tech stocks, with a focus on crypto regulation and DeFi.

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