Do Your Assets on Exchanges Actually Exist?

In terms of credibility, the last year or so hasn’t been crypto’s finest hour. Several big, well-established players from across the crypto world – like Three Arrows Capital in Singapore and Celsius Network in the United States – have become insolvent, and more appear to be heading in that direction. “The dominos are falling,” said Gate.io founder Han Lin. “Some exchanges already have serious solvency issues.”

Bankruptcies and looming collapses are terrible news for crypto, and not only because they push down asset prices. Even more seriously, they deal hammer blows to the industry’s reputation, causing users to lose faith and securities regulators to become heavy-handed. For the collective wellbeing of crypto, it’s imperative that all coins, exchanges and crypto firms stop falling into the same traps and start rebuilding trust.

There are two major things that exchanges, which are nothing less than the arteries and veins through which cryptocurrencies flow, can do to achieve this. First, they need to put proper user-first risk management at the heart of their business models, partly by offering products and services that do not expose their users’ assets to unmitigable losses, and partly by taking a responsible approach to how they hold user assets. This is especially a priority in view of the fact that in many parts of the world where economic governance is weak, more and more people are relying on crypto as an asset that will keep their life savings safe.

Second, having made their business models sustainable and user-centric, they need to develop and implement new and robust ways to transparently show that user assets are secure on their platforms.

Taken together, these two requirements point in one direction: Exchanges should hold 100% of user assets, and their reserves should be validated by credible auditors and user-verifiable auditing methods.

This is exactly the approach that has been pioneered by Gate.io, one of the world’s earliest cryptocurrency exchanges. Since it was founded nine years ago, the firm has built a reputation for safety, security and transparency as it has expanded its user base across the globe. It was the first cryptocurrency exchange to provide 100% certified and user-verifiable proof-of-reserve, together with a reputable auditing firm.

If exchanges are to weather the current market storm, they might want to think about taking inspiration from Gate.io’s auditing approach.

Since at least the 19th century, a cornerstone of trust in the corporate and finance worlds has been the regular use of third-party audits conducted by reputable experts. If this practice was deployed systematically in the crypto industry, it’s likely that many of the collapses that have hurt so many innocent investors over the past couple of years could have been avoided.

Kicking off in 2020, Gate.io pioneered the first proof-of-reserves audit reporting for a digital asset exchange with Armanino LLP, one of the top accountancy and auditing firms in the U.S to prove 100% collateral. As you would expect, Armanino conducted a conventional audit and produced an independent report in line with the standards set by the American Institute of Certified Public Accountants. The first audit finished in 2021, and the second one is underway with a target completion of fall 2022.

However, what makes the auditing relationship between Gate.io and Armanino truly groundbreaking is the use of a patented transparent, public and immutable technology to verify the exchange’s proof of reserves.

Merkle trees, a key architectural feature and innovation in blockchain technology, allows the transparency and verifiability that has made so many millions of people around the world embrace crypto as an alternative to opaque, state-controlled currencies. The fact they’re the basis of trust in cryptocurrencies themselves is a powerful argument for why they should serve a similar purpose for crypto exchanges. For this among other reasons, a third-party generated Merkle tree is the central mechanism of Gate.io’s proof of reserves.

Gate.io submits all its users’ balances in tokenized form to Armanino, which then generates the Merkle tree. The auditor next verifies the total user balance before publishing the tree and its root hash on GitHub. Gate.io’s users are able to download the tree and, by entering their own hashed user ID and token balance, check their balance against the corresponding entry in the tree. Users can also verify the tree’s root hash to confirm that the tree is accurate and whole. Learn more about the Merkle tree feature.

Gate.io’s work with a third-party auditor is indicative of its commitment to adhering to local regulatory standards across all of the jurisdictions in which it’s based. Moreover, the exchange seeks to enhance user security across all the layers of its IT infrastructure, from login and authentication features to asset management, on-platform security, software development and data management and storage.

Gate.io believes that the procedures and commitments it has developed around transparency and security serve the best interests of its users, the firm’s own health and the reputation of the entire crypto industry. Looking to the future, as it expands into new jurisdictions, the exchange will comply with local regulatory standards, just as it has done by working with Armanino in the United States. This, rather than an opaque and reckless approach to risk and solvency, is the model for exchanges to follow if they too want to help the crypto sector expand its user base in a sustainable, trustworthy way. You can find out more about Gate.io’s unique proof-of-reserves model here.

“Gate.io provides users with an unmatched selection of assets and trading pairs, supported by high volume and our comprehensive security approach,” Lin said. “Our offerings culminate into a highly liquid trading experience where users' crypto journey can be limitless, dependable and safe, with a heavy emphasis on the latter.”