Proof-of-Reserves: What is it & How Does it Affect Your Crypto – India Today


In light of the recent FTX debacle, it could be hard for one to trust the safety of their assets. The cryptoverse is on the outlook for a foundation built on enhanced trust, belief, security, and credence, which is why more and more exchanges are shifting towards a Proof-of-Reserves mechanism.

By Jasmine Anand:

After the mayhem caused by the FTX debacle, several cryptocurrency firms are deploying the Proof-of-Reserves system, a method which ensures transparency to centralised crypto reserves. So, in order to understand this mechanism better, let us take a deep dive into what exactly the Proof-of-Reserves method is.

Proof-of-Reserves, commonly known as the PoR method, is a verifiable auditing procedure which addresses the transparency concerns on assets held on exchanges. In other words, Proof-of-Reserves is a way to verify that an institution, i.e., a crypto exchange has sufficient reserves backing all customer balances.

This method addresses the transparency concerns on assets held on exchanges and ensures that the crypto is backed by real assets.

Why Proof of Reserves is the need of the hour?

Considering the recent upheaval caused by the FTX collapse, the Proof-of-Reserves is crucial, as it:

  • Benefits both customers as well as users.
  • Offers transparency to customers about the availability and backing of funds.
  • Enhances customers’ trust, thus, allowing them to independently and cryptographically verify that their account balances are included in the said system.
  • Moreover, it protects them by minimising security risks and safeguarding them against harmful players.
  • Drives businesses to meet transparency standards, making it difficult for them to engage in questionable or illegal financial activity.

PoR makes use of Merkle trees

Proof-of-Reserves is done using the ‘Merkle Tree,’ which is an anonymised proof of client balances, allowing anyone to cryptographically verify that the exchange holds their funds and that their account balances are included in the PoR.

This technique aggregates the total of all customer balances without exposing any private information. The total aggregate data is then accessible via the Merkle root, which is the tamper-proof cryptographic fingerprint that auditors can access to verify the balance information. Using the Merkle tree hashing mechanism that underpins blockchain technology keeps the data secure and protected from any tampering or hacks.

Here, it is pointed out that the Merkle Tree is created and maintained by an independent auditor.

Binance’s CZ views on the use of Proof of Reserves

The crypto contagion has almost engulfed the entire cryptoverse, with several top tokens witnessing a huge plunge in their value. During this time, when investor sentiment is low and the market is battling recessionary fears, Changpeng Zao, Binance’s CEO, also known as CZ, has announced employing a Proof-of-Reserves audit to ensure complete transparency of asset management. This method has swiftly drawn a lot of investor attention, garnering widespread support.

Which exchanges have deployed the POR method?

Binance, one of the leading cryptocurrency exchanges across the globe, released the Proof-of-Reserves system for BTC holdings last month.

Even ByBit, another renowned cryptocurrency exchange, launched this system a few days back. The new mechanism allows its users to directly verify Bybit’s holdings, along with their personal assets deposited into the exchange.

Controversy regarding Proof-of-Reserves

Although the PoR method assures that a crypto company has the assets in place to cover its liabilities, many experts do not consider this as a foolproof mechanism.

They opine that the method is only a single snapshot in time, not a live accounting of balances over time. Moreover, it reflects only the on-chain assets of the custodian and does not track where those assets come from.

In a nutshell, Proof-of-Reserves is a step in the right direction for any crypto company. As countries all over the world are aiming for tighter cryptocurrency regulations, any crypto exchange or firm that acts as a custodian on behalf of its customers would benefit from this method. While the process does have some downsides, it can provide customer assurance and bolster their confidence.

Published On:

Dec 15, 2022

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