Two cycles ago, few in the Bitcoin community knew or cared about Michael Saylor and his software analytics company, Microstrategy (now renamed to just “Strategy”).
But what has become a stock market darling in 2024/25 started as a stagnating company trying to figure out what to do with $500 million in cash equivalents at a time when the pandemic had forced central banks around the world to drop interest rates to zero.
Fast forward five years and the decision to preserve their capital in Bitcoin paid off. But it has since evolved into a playbook in financial engineering, where Strategy raises cash through debt and equity issuance to purchase as much Bitcoin as possible with every round of financing.
MSTR’s performance of 2,918.53% over 5 years has other obscure companies taking note, and we’re starting to see the Bitcoin Treasury roll out with over 100 companies now holding Bitcoin on their balance sheet.
So what could go wrong when more than a hundred public companies start hoarding bitcoin (BTC) on their balance sheets in hopes of boosting their stock prices?
A Short History Lesson
Companies aren’t the golden standard in self-custody, and we have several examples to draw from, such as Mt. Gox and Quadriga CX, as well as recent cycles’ examples like BlockFi and FTX, which serve as friendly reminders of what can go wrong.
But you’re probably thinking, well, those were sleazy crypto exchanges, fly-by-night businesses, not publicly listed entities with a track record, established business models, and access to the world’s deepest and most liquid capital markets.
And you’re right.
But with the scars left behind by high-profile cryptocurrency exchange collapses and corporate treasury mismanagement, one phrase has become increasingly common in Bitcoin circles: “proof of reserves.“
Companies proudly display their Bitcoin holdings, cryptographically proving they control substantial amounts of the digital asset.
Yet this transparency tells only half the story.
The missing piece—proof of liabilities—remains one of the most challenging and trust-dependent aspects of Bitcoin company operations, creating a fundamental paradox in an industry built on trustlessness.
Understanding Proof of Liabilities
Proof of liabilities represents a company’s ability to demonstrate what it owes to customers, creditors, or other stakeholders.
For Bitcoin exchanges, this typically includes customer deposits on exchanges, Bitcoin held in custody, lending obligations, or corporate debts denominated in Bitcoin.
For Bitcoin treasury companies, this includes the amount of Bitcoin advertised on their balance sheets.
While proof of reserves shows what a company controls, proof of liabilities reveals what they’re obligated to return or payout.
The concept seems straightforward: a company should be able to prove it has enough assets to cover its obligations. In traditional finance, this is accomplished through audited financial statements, regulatory oversight, and standardised accounting practices.
The Technical and Practical Challenges
The difficulty in proving liabilities stems from several interconnected factors. Unlike Bitcoin addresses, which are publicly visible on the blockchain, liability records exist in private databases and internal systems.
A company can cryptographically sign a message proving they control a Bitcoin address, but they cannot similarly prove the completeness or accuracy of their internal liability records.
Consider a Bitcoin exchange with 100,000 customers.
While the exchange can prove it holds 10,000 Bitcoin in cold storage, proving it only owes 9,500 Bitcoin or 10,500 to customers requires trusting the exchange’s internal records. There’s no cryptographic method to verify that the exchange hasn’t hidden additional liabilities, understated customer balances, or maintained off-the-books obligations.
This creates what cryptographers call the “completeness problem.” Even if a company provides a cryptographic proof of their stated liabilities, there’s no way to verify they’ve included all obligations.
They could maintain hidden liabilities, unreported loans, or undisclosed customer accounts. The blockchain shows what flows in and out, but it cannot reveal the internal accounting that determines who owns what.
Privacy concerns compound these technical limitations.
Customers expect their account balances and trading activity to remain confidential.
While techniques like Merkle trees and zero-knowledge proofs can prove liabilities without revealing individual account details, implementing these systems requires significant technical expertise and ongoing maintenance that many companies lack. Additionally, this solution is not bulletproof, as it still requires trust in all participants.
The Trust Dependency Paradox
This brings us to Bitcoin’s central paradox: an industry founded on eliminating trusted intermediaries must rely heavily on trust when proving liabilities. Bitcoin’s core innovation was removing the need to trust banks, governments, or other third parties.
Yet when companies hold Bitcoin on behalf of others, customers must trust that these companies accurately report their obligations.
The irony runs deeper than simple technical limitations. Bitcoin’s transparent blockchain creates an illusion of verifiability that doesn’t extend to liability management.
Customers can verify that their exchange holds significant Bitcoin reserves, leading to false confidence in the platform’s solvency. This partial transparency can be more dangerous than no transparency at all, as it masks the hidden risks lurking in undisclosed liabilities.
Traditional financial institutions operate under comprehensive regulatory frameworks that mandate regular audits, capital requirements, and reporting of liabilities.
But even when audits occur, they typically rely on company-provided data rather than independent verification of all obligations.
How Trust Can Be Abused
The trust-dependent nature of liability proofs creates numerous opportunities for abuse. Companies can manipulate their liability reporting in ways that would be impossible with reserves.
They might temporarily reduce reported liabilities by encouraging customer withdrawals before audit dates, then allow balances to rebuild afterward. This creates a false snapshot of solvency that doesn’t reflect the company’s true financial position.
More sophisticated manipulation involves liability shell games, where companies shift obligations between subsidiaries, jurisdictions, or time periods to obscure their true exposure.
A company might transfer customer deposits to a subsidiary before reporting, making their liabilities appear smaller while technically maintaining control of the assets. These practices are difficult to detect without comprehensive, real-time auditing that most Bitcoin companies don’t undergo.
The fractional reserve problem represents another form of abuse. Companies can lend out customer deposits while maintaining sufficient reserves to handle normal withdrawal patterns.
This practice, common in traditional banking, becomes problematic when customers believe their Bitcoin is held in full reserve.
The company maintains technical solvency while operating with significantly more risk than customers understand.
Some companies exploit the complexity of liability proofs by providing incomplete or misleading information.
They might prove liabilities for one subsidiary while hiding obligations in another, or demonstrate solvency at a specific moment while maintaining unsustainable positions over time. The technical complexity of proper liability proofs makes it difficult for customers to identify these manipulations.
The Path Forward
Addressing the challenge of proving liabilities requires accepting their inherent limitations.
Real-time attestations, where companies regularly publish cryptographic proofs of their current liabilities, can reduce the window for manipulation and put pressure on them to operate efficiently. However, these systems require significant technical investment and ongoing maintenance.
As an investor in these companies, you have to be comfortable with that “what if”.
- What if they don’t have the Bitcoin they claim to have?
- What if they’ve rehypothecated the Bitcoin
- What if they’ve lost the keys to that Bitcoin
- What if they’re commingling funds with another entity
- What if they’ve leveraged the Bitcoin to finance riskier plays
- What if the company has a liquidity shortfall and becomes a forced seller
Standard Chartered Sounds The Alarm
Off the back of Bitcoin Treasury mania, Standard Chartered is sounding the alarm. The bank has reviewed the average price at which these publicly listed companies acquire Bitcoin and claims to see chinks in the armour.
It warns that if Bitcoin sheds 22% of its value relative to a firm’s average BTC purchase price or if Bitcoin dips below $90,000, half of a subset of sixty-one public companies currently employing a BTC treasury strategy will go “underwater,” in other words, the market value of company shares will be less than the value of Bitcoin held.
Not every one of these companies on the growing list is a Bitcoin-focused play, has the board commitments and shareholder base that MSTR has, and a bear market shakeout could lead to abandoning Bitcoin.
There will be cabbage-hand treasury companies.
No Need For Trust When You Can Verify
Proof of liabilities represents one of Bitcoin’s companies’ most persistent challenges since they live and die by the unencumbered Bitcoin they hold on their balance sheets.
While proving reserves has become relatively straightforward, proving liabilities remains dependent on trust in ways that contradict Bitcoin’s fundamental principles.
If you don’t feel comfortable trusting an intermediary with your money or your Bitcoin exposure, the beauty is that you don’t have to accept the deal; you can go direct and purchase Bitcoin, holding it in self-custody.
The safest way to hold Bitcoin for the long term.
