Bankless: Should we worry about currency security?

Disclaimer: This article aims to convey more market information and does not constitute any investment advice. The article only represents the author's viewpoint and does not represent the official stance of MarsBit

Disclaimer: This article aims to convey more market information and does not constitute any investment advice. The article only represents the author's viewpoint and does not represent the official stance of MarsBit.

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Source: MarsBit

In the past week, Coin An has found itself the focus of many cryptocurrency doomsayers, who are concerned that a large-scale CEX will follow the footsteps of FTX.

Where does this concern come from? Is FTX2.0 coming soon? Should the encryption industry be concerned? Let's answer these questions one by one.

FTX went bankrupt in November because it was an exchange that functions more like a bank - trading customer deposits when they should not be trading them. After its shocking bankruptcy, other crypto exchanges signaled that they had not done the same unseen thing. Their goal is to achieve this by promising to showcase what they call 'proof of reserves'.

At the center of the farce performed by Coin An over the past week is an immature attempt.

Coin An has released a 5-page audit of its reserves conducted by financial audit firm Mazars based on some "agreed upon procedures".

Disadvantages of auditing

Firstly, this report only audited Bitcoin installed on the selected chain:

In this agreement, the spot, options, margin, futures, financing, loan, and earning accounts of Bitcoin ("BTC") and packaged Bitcoin ("BBTC" and "BTCB") held by customers on Bitcoin, Ethereum, BNB chain, and Coin Security smart chain blockchains will be defined as assets within the scope.

In addition to Bitcoin, the report also studied a series of public addresses chosen by Coin Security:

Mazars will search for ETH and/or BSC addresses on Etherscan and BSCScan respectively to ensure that these addresses have been marked as belonging to Coin Security.

Among these narrow parameters, the Mazars report summarizes three relevant numbers:

Source: Mazars' Currency Security Reserve Certificate Report

The first and third numbers claim that at the time of the audit (November 22), Coin An held a total of 582486 Bitcoin assets and 597602 Bitcoin customer liabilities. This means that the Bitcoin reserve gap of Coin An is 1:1, which is 15116 Bitcoins (2.5%).

However, users of Coin An can also borrow Bitcoin from the exchange as part of their loan plan. When we included the loans of 21860 Bitcoins (597602 minus 575742) in the assets of Coin An, its liabilities decreased to 575742 Bitcoins, indicating that Coin An was over collateralized by 15117 Bitcoins.

Therefore, the conclusion drawn from the audit is that the Bitcoin funds of Coin An are secure. But people (naturally) are dissatisfied with Mazars' audit, as it is hardly a traditional audit.

Why only Bitcoin? What is the loan situation of Coin An on ETH, USDT, or BNB? These funds have been omitted from the "liabilities" section of Coin An's balance sheet.

What about Bitcoin assets that are not on the above three chains? Any packaged Bitcoin loans that Coin An may have borrowed on Solana or Avalanche chains are also missing.

The entire process is a bit like having an audit company audit a bank, but only checking specific currencies in certain bank accounts.

Finally, there is another issue of treating packaged Bitcoin and Bitcoin interchangeably. This masks the security risks involved in packaging assets, as they should be supported by equal underlying values in the packaging token. It is speculated that Coin An will hold a 1:1 ratio for each BTCB and BBTC it issues, but this is not yet clear. Mazars audit believes that packaged Bitcoin is fundamentally secure, but to our knowledge, Coin An may have issued more collateral than its underlying collateral.

Mazars' report does at least one thing well: it is transparent about some of the debts of Coin An. Most reserve certificates do not disclose any data on balance sheet liabilities. But because it ignores all non Bitcoin assets, it cannot fully prove the financial health of Coin An.

Coin An stated that it will disclose more information about its other assets in the near future. But currently, the audit only proves a part of the currency security reserve, rather than a comprehensive view.

All the commotion led Mazars to announce on December 16th that they would cease auditing work on Coin and its other encryption clients, including Kucoin and Crypto.com.

What is the actual situation of Coin An?

Rumors have spread and people are panicking, but everything seems to be going as usual for Coin On. The company announced on Monday that its US subsidiary has reached a $1 billion deal to acquire Voyager's assets.

So, what is the situation with Coin An?

Coin An has experienced a massive outflow of billions of dollars in the past week, with an outflow of 4.27 billion dollars on December 14th alone. This is to some extent triggered by the on chain data of well-known TradFi players such as Jump and Wintermute withdrawing funds from Coin An on the 12th.

Although these are some stunning numbers, let's take a look at them in the background. The proof of total reserves reported by Coin in other places (not to be confused with Mazars reports that only audit Bitcoin) shows that as of December 19th, the quantity was $55 billion, lower than the $70 billion before the current public relations crisis began.

https://twitter.com/nansen_ai/status/1603949786771517440

If Coin An is nearing its end, it will display as close to zero on ETH and stable currency asset outflows, just like in the case of FTX.

Although there has been a large-scale outflow of funds due to users' desire to avoid any FTX2.0 opportunities, on chain data tells a different story. The stable currency and ETH reserves of Coin An are still around 22B and 5M, respectively.

Source: CryptoQuant

One important reason why FTX is in trouble is also to use its own FTT tokens to mortgage loans. FTX is an exchange that functions as a bank: it trades customer deposits when they should not be traded. This is a house of cards based on trust and dependence itself, rather than collateral with more stable financial conditions such as US treasury bond bonds, BTC or ETH.

If Coin An's business is built similarly on its own BNB tokens, we may have more reasons to worry. Fortunately, only about 10% of Coin An's reserves are composed of BNB, which is roughly the same as most other crypto exchanges.

Source: CryptoQuant

BNB is also different from FTT in one important aspect: its utility. FTT is used for discount trading of FTX, but if the public thinks your exchange is about to become insolvency, FTT will not play any role. On the other hand, BNB is also an asset used by TVL: BNBchain today to verify and pay transaction fees for the second largest L1 chain.

The price of BNB plummeted to $221 on December 17th, but has now rebounded 11% to $241.

Source: Coinmarketcap

last

All these indicators indicate that although Coin An is experiencing a certain degree of bank run, the situation is definitely not as unstable as claimed on Twitter.

A 'bank run' may not be appropriate here, as Coin An is an exchange, not a bank. As long as it holds all customers' deposits in a 1:1 ratio according to service terms (unlike FTX), even if each user wants to withdraw their money, no one will lose a penny.

The problem is that we don't know for sure about this, which is why holding cryptocurrency on a centralized exchange is never as secure as holding cryptocurrency in our own unmanaged wallet.