In the mad rush to calm worried investors and prevent bank runs following the sudden collapse of FTX, crypto exchanges and lending firms have been publishing their proof-of-reserves. The process, which entails confirming an entity’s assets at hand, has exposed glaring issues eliciting mixed reactions in the crypto community.
On November 9, KuCoin became one of the firms to declare that they would release Merkle tree proof-of-reserves “POF” in a month and work closely with auditing institutions to build confidence and transparency in the industry. However, days after making the announcement, the crypto community is now afraid that the exchange’s reserve allocation is somewhat similar to what led to FTX’s collapse.
On Monday, The Block Research, a platform that shares leading research and analysis on the digital asset industry, wrote;
“KuCoin holds nearly one-fifth of its reserves in KCS, its own exchange token. Should this percentage start growing rapidly, it may become a cause for concern, just like how the illiquid FTT formed the bulk of FTX’s balance sheet.”
According to a chart provided by the firm, Kucoin’s holdings are dominated by USDT at 28.96% while its native coin, KCS comes in third at 18.83%. Notably, second in position is a combination of coins marked “others”, which logically suggests KCS could actually be the second largest token holding for the exchange.
And while there is nothing untoward about Kucoin holding such a vast amount of KSC, FTX’s collapse shows that it is a bad idea for exchanges to sit on vast stashes of their tokens. Moreover, the collapse also shows the danger of a rival exchange holding a considerable sum of another exchange’s tokens.
As ZyCrypto reported, FTX’s sudden collapse was partially caused by concerns over the exchange’s FTT token after it was established that the highly illiquid tokens dominated Alameda Research’s balance sheet.
As of June 30, Alameda held $3.66 billion of “unlocked FTT”, with $2.16 billion of that amount being used as collateral. A November 6 tweet by Binance CEO Changpeng Zhao that they would liquidate any remaining FTT on Binance books ignited a dumping frenzy on FTT plunging the token by over 94%.
Exchange tokens also face what is known as “counterparty risk.” This term is used in crypto when the issuers claim that real-world assets like stablecoins back their exchanges tokens. In the event investors exchange their BTC or ETH for those tokens and liquidity dries up, plunging the exchange token value, those investors have no way to reclaim their BTC or ETH.
However, Johnny Lyu Kucoin’s CEO recently said that KuCoin’s financials are up to scratch, dispelling any FUD targeting the exchange.
“Since its launch in 2017, KuCoin has always adhered to long-term growth and risk-free business strategy. This helped us go through bear cycles and market turbulence, and continue growth,” he tweeted.