In the wake of its sudden liquidity crisis, FTX, which was the third-largest cryptocurrency exchange by trading volume at the time, filed for voluntary Chapter 11 bankruptcy. The company, having only $900 million in liquid assets against nearly $9 billion in liabilities, found itself unable to meet its customers’ withdrawal demands and was compelled to cease operations.
Impact on the Cryptocurrency Industry
FTX’s downfall had a profound impact on the cryptocurrency sector. Bitcoin (BTC) and various other cryptocurrencies plummeted to their yearly lows, and the collapse triggered a series of disruptions and failures among other entities within the industry. The full extent of the damage remained unclear, particularly regarding which major industry players had significant exposure to FTX and might face their own closures. Additionally, over one million users experienced financial losses as a result of the collapse.
Emergence of Proof of Reserves
The FTX collapse highlighted the risks of storing funds on centralized platforms. In response, several cryptocurrency exchanges began adopting Proof of Reserves to restore trust.
What Is Proof of Reserves?
Proof of Reserves is a method used by crypto exchanges, lenders, and custodians to show their financial stability and ensure user balances are fully backed by assets on the blockchain. Binance CEO Changpeng Zhao led the call for exchanges to use Merkle tree-based Proof of Reserves to avoid fractional reserves.
Merkle trees encrypt blockchain transaction data, allowing users to verify that exchanges securely hold their funds. This method enables easy auditing of the exchange’s total holdings and lets individuals confirm their specific transactions.
Adoption of the New Standard
Following Binance’s push on November 10, 2022, many major cryptocurrency exchanges committed to the new Proof of Reserves standard. As of now, most exchanges have provided basic audits or detailed wallet breakdowns, while only a few have posted fully auditable Merkle tree Proof of Reserves.
This new standard aims to improve transparency and rebuild trust in the cryptocurrency industry, addressing vulnerabilities exposed by FTX’s fall.
