Building Trust in the Crypto Ecosystem: A Framework For Centralized Exchanges
Main Takeaways
We are in the middle of a watershed moment for the digital asset space. Rebuilding user and regulator trust will be critical for the future of the whole industry, which is still in its early stages.
It is incumbent upon the industry’s key players such as centralized crypto exchanges(CEXs) to step up and prove that bad actors do not define the digital asset ecosystem.
Striving to lead by example, Binance has articulated an actionable framework for centralized cryptocurrency exchanges designed to facilitate building public trust in the crypto ecosystem.
Digital assets hold enormous potential to promote financial freedom and improve people’s lives, offering a model of a more equitable, transparent, and efficient transfer of information and value online. Yet, this industry is still in its infancy, and we must tread extremely carefully as more and more people enter this innovative space and entrust it with their money. Developments over the past year that rocked the crypto ecosystem have underscored the utmost importance of trust and safety.
Responsibility to Regain Trust
Rebuilding user and regulator trust will be critical for the future of the entire industry. To a large extent, it is centralized crypto exchanges that represent the space in the eyes of the public and policymakers, who will now demand even more than what is currently required of traditional financial institutions when it comes to transparency and security.
Thus, centralized exchanges, along with all other players in the digital asset space, have a fundamental responsibility to demonstrate that a handful of bad actors do not define this industry. Winning back policymakers, regulators, and the community’s trust will require putting risk management, transparency, and security front and center. As the largest crypto exchange by volume globally, Binance embraces its duty to the digital asset space and strives to lead by example.
To this end, we have shared an actionable framework that guides our own efforts to build a secure crypto ecosystem founded on trust. We are in this together, and no single industry player can pull this weight alone. To help our ecosystem move forward, we call for all centralized exchanges and other blockchain firms to embrace this ethos of responsibility. Outlined below are the domains that we see as fundamental to trust-building, as well as specific guidelines we propose in each of these domains.
Components of Trust
Handling Customer Assets
Crypto service providers’ fundamental responsibility is to protect user funds. Customer assets should only be used in the ways that the customers have explicitly authorized.
Exchanges must allow users to decide where and how to store their digital assets. Depositing and withdrawing funds to and from the exchange should be a simple, cost-efficient, and seamless process. Storage solutions that exchanges utilize should meet the highest security standards so that user assets remain safe from malicious actors at all times.
At Binance, user assets are secured by reserves at a 1:1 ratio and are never used for unauthorized purposes. Furthermore, we maintain the highest security standards for our wallet security infrastructure.
User Funds Transparency
A core prerequisite for trust is user funds transparency. Users who trust us with their money have every right to verify the safekeeping of their assets held in a centralized exchange’s custody at any time – through proof of reserves or a similar disclosure system. Regardless of the method, it must be technically adequate, intuitively understandable, regularly updated, and subject to verification.
Binance has taken several important steps toward greater transparency of user funds. We built and implemented a Merkle tree-based proof-of-reserves system for users to verify their assets held on our platform in November 2022. In February 2023, we strengthened our core user funds transparency solution by implementing zk-SNARKs, a type of zero-knowledge protocol. Combining zero-knowledge proof and Merkle tree information, it gives users a new and improved way of verifying the state of Binance’s reserves in a private and secure manner. Anyone can now verify that each user account’s net balance is non-negative and that all user assets are part of Binance’s claimed total net balance of user assets.
Risk Management
Just as with any other organization that handles users’ funds, prudential considerations are central to centralized crypto exchanges. The risks of using debt to fund growth are exacerbated by digital assets’ volatility, so companies in this space should practice a conservative approach to structuring their capital. At Binance, we believe that it is unwise to take on debt to fund growth, which is why Binance’s capital structure is debt-free.
If a CEX offers wrapped tokens for use on a different blockchain, such assets must always be collateralized 1:1 on their native chain, and there should be a way for the community to verify that this is the case. Binance offers a range of wrapped tokens to use on different chains, such as BTCB and BBTC. Our wrapped tokens are always collateralized 1:1, and anyone can verify this.
Low-quality crypto projects whose primary goal is to get their tokens to trade on a major exchange can also pose risks to these platforms’ customers. Centralized exchanges have a critical responsibility to implement a strict governance process for admitting crypto assets to trading on their platforms to protect users. Binance adheres to strict vetting protocols before listing new assets. To illustrate, out of 450 projects that filed Binance Launchpad and Launchpool applications in the first half of 2022, only 5 ultimately saw their tokens listed.
Centralized exchanges should introduce safety-net measures to guard users against unforeseen circumstances that can result in loss of funds. To that end, Binance maintains its Secure Asset Fund for Users (SAFU) worth $1B.
Ultimately, the best way to protect users from risks associated with digital assets is to educate them on these risks and ways to address them. All exchanges must dedicate resources to provide customers (as well as the wider community, including regulators, law enforcement officials, and policymakers) with sufficient knowledge about their products, services, and the broader industry. Educational material should clearly explain the risks inherent in various products to enable users to make informed choices. An example of such a resource is Binance Academy – a blockchain and crypto learning portal that hosts free educational resources in over 25 languages, including some 400 articles in addition to videos, and online courses on a variety of topics. In November 2022, Binance Academy launched its first online course series, with more to be added soon.
Rising tide
We believe that a rising tide lifts all boats. By following these guidelines, we can make everyone in the digital asset space safer. The more blockchain platforms choose to raise the bar of transparency and responsibility, the better off we will be as an industry. Speaking from a place of humility, we call for our colleagues throughout the Web3 space to join us in this push toward an ecosystem built on security and trust.