2022 did not go as planned. The crypto industry posted a big one reject which caused a huge stir in the market. This fall was further caused by Sam Bankman-Friend’s FTX. Not only did the exchange’s defeat bring about correction, but it also forced the community to lose faith in it centralized exchanges.
To build trust in the community and emphasize transparency, Proof of reservations [PoR] had been set up. Crypto industry exchanges were urged to jump-start the PoR process.
What is Proof of Reserves?
Using the technique of Merkle trees, HbR is quite popular among exchanges. It is a vetting technique that ensures crypto has real support on exchanges. An PoR audit ensures that custodians have all their customers’ money in their hands.
To achieve transparency between the general public and investors, cryptocurrency custodians use PoR audits. To exclude falsification of reserve data, these audits are carried out by neutral third parties.
Since the account balances of all these custodians will be made visible, it is almost impossible for them to go wrong. Moreover, exchanges would not invest their money in other methods or companies.
How does the HbR work?
During an PoR verification, the auditor uses cryptography to confirm the withdrawal of each account’s balance. As mentioned earlier, the Merkle Tree technique plays an important role. Large amounts of data for easier processing. As a result, a Merkle root identifies and adds up the balances of all accounts.
The balances would be verified on public blockchains. The assets are held by digital signatures set by exchanges. Details regarding the balance and assets on public blockchains are validated. These numbers must be balanced to maintain consistency.
In addition, systems will be set up for clients to verify the validity of the assets they hold. Any possible data changes will affect the Merkle root, which may indicate asset manipulation.
Who does it?
This technique received a lot of attention from the entire industry. A series of networks decided to implement the same. Binance quickly jumped on it and rolled out an HbR system for it BTC holdings. CZ even continued urge its counterparts to set up the same.
A recent listing highlighted how a plethora of exchanges had joined the HbR bandwagon. Several platforms have announced the cold wallet address of their reserves. This included Binance, Bitfinex, OKX and others. MEXC and Bitget have yet to disclose their PoR assets.
According to recent data compiled by prominent Chinese journalist Colin Wu, Binance brought in a whopping $64.17 billion in assets on its platform. This included $7.87 billion in BTC, $5.9 billion in ETH, $14.24 billion in USDT, and $19.23 billion in BUSD.
Bitfinex stood down Binance. However, the difference between the reserves of the platforms was quite large. Bitfinex’s total reserve amounted to $7.32 billion, which was quite dainty compared to Binance.
Okay, Huobi as well as Crypto.com also brought significant reserves. With all these prominent exchanges being more transparent, the community got some respite.
Restrictions of PoR
While this would certainly increase confidence in the crypto ecosystem, PoR has its own shortcomings.
For example, consumers move their assets in and out, which would lead to changes in the balance of the crypto exchange. The problem with PoR is that it only checks the correctness of reserve balances during the appropriate audit window. Therefore, this can be problematic as any errors will not be revealed until it is too late. A custodian could take advantage of the situation to distort the truth.
Stolen money and loss of keys can further reveal discrepancies in the verification process. Unfortunately, the Proof of Reserves procedure cannot reveal whether an exchange has borrowed money to pass an audit.
Finally, there is a chance that the auditor and the auditee will work together. While both parties must maintain transparency, outside interests can influence them.
KuCoinfor example, rented Mazars, an international accounting and accounting firm for performing PoE. In addition, this company previously audited the accounts of former President Donald Trump. While some were ecstatic, a few others expressed fear at this news.
Has PoR brought peace to the community?
Now that PoR has only just entered the spotlight, the industry has yet to see its real usefulness. As it maintains transparency and controls crypto exchanges, this could be a step towards gaining community trust.
If the anticipated shortcomings of the process attract attention, PoR can help restore confidence in the market.