Four years after FTX, crypto exchanges still prove assets without proving solvency

A customer opens an exchange account, copies a string of numbers and follows a path through a Merkle tree. The page processes the request and returns a reassuring result: the customer’s balance was included in the exchange’s proof of reserves.

The verification is most likely technically sound, establishing that the account appeared in a dataset and that the exchange controlled wallets that contained enough of a particular asset to cover the balances represented there.

However, it can easily leave out whether every customer appears in that dataset, how much the exchange owes to lenders, whether the displayed coins have been pledged as collateral, and whether the company actually controlling the wallet is the same company that's legally required to repay the customer.

The interface on most exchanges makes this reserve verification process feel pretty comprehensive and final because people tend to give more authority to cryptographic evidence than to corporate promises.

But what many miss is the fact that the result only establishes that an exchange demonstrated control over specified assets at a specified moment. A determination of solvency, on the other hand, requires both a deeper and a wider view of the company’s obligations, ownership structure, and access to funds.