Although the exchange may hold a portion of its reserves in other cryptocurrencies based on user deposits, a substantial part of the portfolio must include hard, highly liquid assets. Alternatively, if the custodian uses Armanino as its auditor, users can usually verify the company’s reserves by visiting their Trust Explorer page. On the dashboard for each company, it is possible to verify individual balances or review the current status of the company’s reserves. Nexo launched in 2018 and offers a platform for users to earn interest on their crypto or draw credit lines using their crypto as collateral. In September 2021, Nexo also introduced a proof-of-reserves program also in partnership with Armanino. Additionally, they can view proof of reserves audit the company’s PoR on Armanino’s website, with the option to download the account report for the most recent attestation period.
Protecting Client Assets – Crypto Exchanges and Their PoRs
- Many exchanges subsequently introduced proof of Reserve to restore the lost trust.
- In the context of what is proof of reserves, Merkle Trees help ensure that every transaction and account balance is accounted for and can be verified easily.
- This is a very common objection by folks in the industry who believe (mostly erroneously) that exchanges have already cheated PoR by borrowing funds.
- Proof of reserves also helps to build trust among customers and investors, as they can see that their funds aren’t going to disappear without warning.
- As a result, the institution could not modify user balances without detection.
Therefore, exchanges need to provide additional information, such as liquidity ratios, so that users can make more informed investment decisions. With the increasing importance of proof-of-reserve audits for verifying crypto assets and liabilities, more crypto exchanges are revealing their proof of reserves figures. However, there are still many that remain https://www.xcritical.com/ secretive about this information. Let’s take a look at which crypto exchanges have disclosed their PoR figures and which ones have yet to make this information public. In case of PoR crypto exchanges, an independent auditor is tasked with verifying whether a given asset has enough on-chain assets that match customer assets. To put it simply – customers are to be sure that they will get their lost funds.
Crypto Proof of Reserves – A Guide
It’s all about verifying that the institution’s holdings are accurate, and that customer funds are properly backed. The cool thing about “Proof of Reserve” is that it keeps the exchange platforms in check and gives customers a sense of assurance. It’s a way for users to double-check that the platform’s liabilities and the amount of crypto they have are matched by the same amount of assets. After the FTX collapse, which was one of the most popular crypto exchanges in the USA and the world, transparency and PoR became increasingly “popular” or demanded in the industry to enable more trust for users.
What Does Proof of Reserve Verification Do?
Since all centralized exchanges can keep their financial sheets private, the customer has no idea what’s happening to their funds. While many exchanges are champions of transparency, others have ended up down a darker path of using customer funds and not having the assets to cover them. A centralized exchange lets you use an account with the premise that, unlike the bank, they will not lend or use customer assets.
Binance Enhances Its Proof of Reserves Security Following Hacken’s Discovery
While the process does have some downsides (such as not tracking company liabilities), it can provide customer assurance and bolster their confidence. The goal of providing proof of reserves is to offer financial transparency about a crypto company’s balance sheet, especially in regard to customers’ funds. A third-party audit gives consumers confidence that the crypto company they are using has sufficient liquidity to handle day-to-day operations, and more importantly, customer withdrawals. Although proof of reserves offers assurance that a crypto company has the assets in place to cover its liabilities, it is only a single snapshot in time, not a live accounting of balances over time. It also only shows the on-chain assets of the custodian; it does not track where those assets come from (i.e., whether the assets were borrowed for the purposes of the audit).
Some exchanges also offer “self-assessment” audits within their platform, instead of using block explorers. Through these self-assessment audits, users can validate if the exchange still holds their funds at any given time. In this case, you can recognize the individual account responsible for depositing the assets with the help of unique digital signatures. Verifying individual contributors involves matching the digital signatures with Merkle tree records.
The cryptographic, public, and immutable nature of blockchain technology allows for particularly transparent and privacy-preserving methods for conducting an audit. In most cases, a data structure called a Merkle tree is used to securely enumerate user deposits and compare them against an exchange’s confirmed holdings. The fall of FTX has affected users’ trust in centralized custodian platforms.
The proof of reserves audit involves an independent third party reviewing and verifying the financial records and holdings of a financial institution. The process typically starts with the institution providing detailed documentation of its assets. The auditor then conducts a thorough examination to ensure that the reported holdings match the actual funds or assets held by the institution.
Kraken implements an “audits” button on user accounts utilizing the Merkle tree functionality. Thus, users can easily verify from their accounts that Kraken included their wallet balances in the most recent PoR audit. Users can also obtain their audit record ID to validate it against a database maintained by Kraken’s auditor — the exchange also uses Armanino. Lastly, users can access technical details from Kraken’s proof-of-reserves page needed to reconstruct a Merkle tree to verify their balances.
Anytime you trust a 3rd party with your assets, you introduce a point of failure. Here are the prominent benefits for custodial institutions with Proof of Reserve evaluation. Blockworks’ Digital Asset Summit (DAS) will feature conversations between the builders, allocators, and legislators who will shape the trajectory of the digital asset ecosystem in the US and abroad. A series of these verifications can then be used to prove the accuracy of the whole tree, without examining each individual one. Additionally, many crypto firms choose to register in places with lax financial oversight, such as the Seychelles or the Cayman Islands.
So, now you know what is proof of reserves, the critical concept that ensures the safety and security of your funds in today’s digital age. You also know that exchanges, which employ it – like Binance, Kraken, or KuCoin – are on the right track. Proof of reserves acts as a safeguard against potential insolvency issues faced by financial entities. It ensures that the funds held by the institution are sufficient to cover all customer deposits and liabilities.
The crypto market’s promise has been largely based on centralized exchange platforms for a long time. These ventures reign even in the era of decentralized finance, as most people find it challenging to handle crypto funds themselves. The mechanism uses cryptographic data structures such as Merkle Trees and public wallet verification to ensure user deposits and reserve balances match.
But this is solved with next generation PoRs which rely on ZK proofs, making disclosure of the full liability set possible without privacy drawbacks. Newer cryptographic technologies have largely made this objection obsolete. Historically, these have consisted of more limited ‘agreed upon procedures’. I am aware that the term is used generally to refer to related procedures. But in the case of stablecoins, it is the liabilities which are on chain and the reserves which are in the banking system. Additionally, the term is sometimes used to refer to a setting in which a wrapped token is compared to equivalent tokens on a different blockchain.
Moreover, PoR checks promote stability within the cryptocurrency industry. Through them, exchanges can demonstrate that they are operating transparently. The audits help attract new users to the industry, encouraging wider adoption of digital assets. Additionally, PoR measures are being actively undertaken by numerous exchanges throughout the industry, so PoR legislation simply codifies an existing process that exchanges have embraced. PoR is a crypto-native solution which, in my view, surpasses the level of assurance you get from traditional audits in a reserve context. After all, all of this regulation is meant to be for the benefit of end users and depositors.
Our proven PoR methodology ensures complete transparency by validating on-chain assets against user liabilities, providing exchanges with the tools to build user trust and ensure solvency. For users, proof of reserves allows them to analyze which exchange would keep their funds safer. For instance, if a PoR audit showed an exchange’s reserves consist primarily of its own coin or token, a user could deem this a risk. On the other hand, if the PoRs show that the exchange’s holdings are well-diversified and over-collateralized, users can have confidence in the exchange. Chainlink PoR feeds can be used for a wide range of tokenized real-world assets (RWAs), such as real estate properties that generate verifiable cash flows.
The bankruptcy of the FTX exchange in November 2022 invited attention to the need for improving audits. In addition, many other platforms, such as BlockFi, Hodlnaut, Celsius, and Voyager Digital, also collapsed. Gate.io is another cryptocurrency exchange that has adopted proof of reserves. The company published its first audit in August 2020 in partnership with Armanino, with the second only coming in October 2022. Cryptocurrency exchange BitMEX introduced a proof-of-reserves-based system in August 2021. The platform is also one of the few to provide visibility into its liabilities.
