Chinese exchange OKCoin today released details of an audit to prove it holds 104.86% of the bitcoin reserves required to cover customer balances.
Going forward, the company will also seek to implement a cryptographic ‘merkle tree’ verification system, allowing users to verify for themselves that their account balance was included in the audit data.
Other China-based exchanges are busy working on audits of their own, following recent demand from the local community for the companies to be more transparent in their accounting.
BTC China announced on 19th August that it would allow an independent third-party audit of its hot and cold wallets, while Huobi is in the process of implementing its own merkle tree-based proof system. Huobi is also working to integrate its newly-acquired multi-signature wallet service Quickwallet.
OKCoin’s audit, which lasted four days, was completed free of charge by Stefan Thomas, CTO of Ripple Labs. Thomas had previously overseen similar audits for digital currency exchanges Kraken and Bitfinex.
CEO Star Xu acknowledged that today’s audit represented “just one point in time”, but promised that more would occur on a regular basis as a necessary step towards financial transparency.
OKCoin’s CTO, Changpeng Zhao, said:
“We have always sought to provide our customers with confidence in OKCoin’s security and world-class technology architecture. Whilst many bitcoin businesses have talked about being transparent, only a handful have taken the necessary steps.”
Huobi’s response
Huobi posted a statement on Reddit detailing its thoughts on the proof-of-reserve matter.
According to its research, Chinese customers tend to use their exchange accounts like banks. As a result, only 20% of Huobi’s reserves are being actively traded, with the remaining 80% remaining dormant between major market movements, it said.
The exchange added that this 80% would be “encouraged and incentivized” to move their funds into the company’s new multi-signature Quickwallet accounts, which would become more tightly integrated with Huobi’s other services to allow for instantaneous transfers.
Huobi also offers ‘Yubibao’ wallets in which customers make their funds available for lending to margin traders, and earn interest in return.
BTC China to hold audits, set up hotline
BTC China said it already makes 100% of its order book publicly available, and will prove its own reserves by allowing independent third-party auditors access to an anonymized accounts database.
A spokesperson told CoinDesk the auditors will be “prominent leaders in the domestic bitcoin industry, with an influential public profile and a vested interest in the honest reporting of the exchanges”. They must also have a strong financial background and a deep understanding of bitcoin.
The audits will then take place on a quarterly and annual basis. Additionally, an international audit team will be selected to satisfy non-Chinese customers, the spokesperson continued.
“While our auditors are prominent within the Chinese bitcoin community, we recognize that to many of our international users they may be unknown. As an international platform, it is very important to us that all of our users, current or potential, have faith in our security and stability as an exchange.”
Why it’s an issue now
Proof-of-reserves for digital currency exchanges has been a sensitive issue in the community since the collapse of Mt Gox in February.
Since that time, exchanges such as Kraken and Bitstamp have taken steps to verify their bitcoin holdings through third-party audits by respected members of the digital currency community.
More recently, however, margin-trading and interest-earning accounts introduced by exchanges like OKCoin, BTC.sx, Bitfinex and Huobi to attract ‘serious’ traders were criticized, perhaps unfairly, for causing the recent sudden drop in bitcoin value.
Users in China, meanwhile, were beginning to question how their local exchanges had grown so large and profitable. Some speculated in various online forums that bitcoin companies were running a fractional reserve system akin to modern-day mainstream banking.
“Of course, this is a very risky practice that can potentially cause a default,” said BTC China, adding that there were concerns about risk management strategies at any exchange offering complex financial products.
User ‘P2PBucks’, who operates a popular Chinese bitcoin portal website, was one of those asking for answers.
He told CoinDesk that users need more action than audits:
“In my point of view, exchanges must [be] under the surveillance of whole bitcoin community. Only merkle tree and third party notaries are not enough – every exchange must disclose their cold wallet addresses.”
“Exchanges are playing a extremely important role in bitcoin world! Market prices are coming out from these exchanges, they are deciding the price, which are used by the whole world. Every bitcoiner must keep an eye on them,” he continued.
Exchange transparency techniques
CoinDesk has previously published a detailed description of what happens when Ripple’s Stefan Thomas performs an exchange audit, using a combination of anonymous account records, bitcoin block merkle trees and other tools developed especially for the purpose.
According to bitcoin guru Andreas Antonopoulos, for audits to be effective at winning customer confidence they need to be thorough and followed up with future examinations.
Audits should also look at the company’s fiat currency operations, and include assessments of security safeguards in place, he said.
Audit image via Shutterstock