"Proof of reserves" including Vitalik's heath robinson crypto schemes, provide minimal assurance to exchange users. Why?
It's what one would call a "limited assurance engagement" in audit parlance. In other words, it provides assurance over a small subset of the balance sheet of an exchange - only the customer deposits and the exchange liabilities pertaining to said customers.
However, there are a few red flags which no-one seems to raise:
1) The customer deposits should be off balance sheet if they actually were held in custody. If deposits are not off balance sheet then customer assets cannot be held in custody. Instead, the customers are a creditor of the exchange.
2) From the terms and conditions I've read for various exchanges, customers are typically not treated as a preferential creditor.
3) In the event of an insolvency, customers are treated pari passu with other creditors.
4) To get sufficient assurance that the exchanges can honour their customer liabilities, we need to see ALL of the liabilities, not just the subset relating only to customer deposits. E.g. Who else is money owned to? Did they issue debt? Did they borrow from a bank? Are there any legal provisions? Etc...
5) Given the legal treatment of customers as unsecured creditors, without entire visibility of the balance sheet, the "proof of reserves" report is pretty much useless.
4) ... this is why tradfi ringfences. One legal entity for the deposits one legal entity for the business. The entity for the deposits has only liabilities to customers + assets from customers.
In fact, on (2) this isn't even something an exchange can do through their Ts&Cs. Local law will decide creditor priority so in the absence of a regulatory framework that treats exchanges as "bank-like" and makes, as a minimum, customer balances "special" in some way, this simply isn't possible.
It's what one would call a "limited assurance engagement" in audit parlance. In other words, it provides assurance over a small subset of the balance sheet of an exchange - only the customer deposits and the exchange liabilities pertaining to said customers.
However, there are a few red flags which no-one seems to raise:
1) The customer deposits should be off balance sheet if they actually were held in custody. If deposits are not off balance sheet then customer assets cannot be held in custody. Instead, the customers are a creditor of the exchange.
2) From the terms and conditions I've read for various exchanges, customers are typically not treated as a preferential creditor.
3) In the event of an insolvency, customers are treated pari passu with other creditors.
4) To get sufficient assurance that the exchanges can honour their customer liabilities, we need to see ALL of the liabilities, not just the subset relating only to customer deposits. E.g. Who else is money owned to? Did they issue debt? Did they borrow from a bank? Are there any legal provisions? Etc...
5) Given the legal treatment of customers as unsecured creditors, without entire visibility of the balance sheet, the "proof of reserves" report is pretty much useless.