Are Centralized Exchanges (CEXs) like Binance Effectively Ensuring User Protection?

    According to Nansen's report, the downfall of FTX has significantly impacted user trust in CEX (centralized exchange). Consequently, users are now demanding greater transparency and security measures.

    Binance and other industry leaders, such as Bitget and OKX, have taken measures to ensure the best possible protection for users and their funds.

    One of the first steps taken by CEXs was to demonstrate their Proof of Reserve (PoR). PoR refers to an exchange publicly disclosing its reserve assets. The goal of PoR is to provide clear and verifiable proof that an exchange has sufficient assets to support user deposits under certain circumstances.

    According to Nansen, Binance’s PoR indicates that the exchange has around $54 billion in reserves.

    Source: Nansen

    Another measure that exchanges have implemented to protect users is the establishment of a protection fund. The purpose of these funds is to provide a backup in case the exchange crashes or gets hacked. Exchanges aim to provide their users with peace of mind by assuring them that, in the event of a hack, the exchange still has enough funds to compensate.

    Nansen notes that Binance has a hedge fund named Binance SAFU, worth $1 billion. OKX comes in second with a $700 million fund. Huobi has two such funds: the Security Reserve Fund and the Investor Protection Fund. The Security Reserve Fund has 20,000 BTC, or about $528 million, while the Investor Protection Fund accounts for 20% of the income, which is used to buy back Huobi tokens. These tokens are used in the user protection fund.

    Source: Nansen

    While the measures taken by exchanges are steps in the right direction, they may not be sufficient. For instance, PoR does not reveal a company’s liabilities, which is one of its main drawbacks.

    For users to have peace of mind, exchanges also need to have an additional “Proof of Liability.” However, it is off-chain and requires an external audit. Moreover, the audits themselves are a concern. Nansen notes that “FTX has undergone auditing before its collapse.”

    Even with a hedge fund, it is essential to adopt risk management best practices, such as spreading cash across multiple locations, to effectively mitigate the impact of multiple attacks. After the collapse of FTX, Binance increased the USD value of the fund from $735 million to $1 billion. Bitget also raised its protection fund from $200 million to $300 million.

    Therefore, it is crucial that exchanges implement more measures to increase transparency and protect users. Many believe that as time goes on, exchanges will put in place more safeguards to prevent a catastrophic crash like FTX’s in the future.

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