Understanding PoR: A Guide to Proof of Reserves

In recent days, FTX, one of the world’s largest crypto trading platforms, filed for bankruptcy. Following FTX’s collapse over the course of just a few days, investors’ confidence in cryptocurrencies continued to drop. To shore up investors’ faith, centralized exchanges such as Binance and Huobi have committed to releasing Merkle Tree-based Proof of Reserves to prove the transparency of centralized trading platforms. Against such a backdrop, Proof of Reserves, or PoR, becomes a hot topic in the crypto market. Truly will take you through proof of reserves, and why it matters in the crypto market.

What is Proof of Reserves?

PoR, or Proof of Reserves, is an independent audit by a third party to verify that organizations/exchanges have balances that match users’ crypto assets in their entirety. Changpeng Zhao, Binance CEO, recently argued that all exchanges should now provide this feature. Proof of Reserves is an independent audit by a third party that provides transparency & proof that a custodian owns the assets it claims to hold on behalf of its clients.

In crypto, PoR is a testament to an institution or an exchange’s capability to meet all withdrawal requests at all times. By disclosing the platform’s cumulative crypto balances (assets) and users’ current total deposits (liabilities), exchanges attest that they have sufficient reserves to meet users’ withdrawal requests. Centralized exchanges, as financial custodians, should not use clients’ funds for any other purposes; therefore, the platform’s total assets should match its liabilities.

Why is Proof of Reserves important, and in what ways?

Today, the crypto industry needs more comprehensive standards to ensure that crypto asset service providers hold enough assets to meet clients’ withdrawal requests, which will to some extent, prevent counterparty risk. Proof of Reserves (PoR) is critical to realize that goal because it’s transparent and verifiable.

1. Build investors’ trust in projects
2. If investors of stablecoin projects suspect that the issuers do not have sufficient reserves to maintain the pegging, anxiety may arise, leading to sell-offs and pushing prices down. And if investors are convinced that a stablecoin has enough collateral, they will maintain their holdings and may buy even more, thus driving prices up. Therefore, investors’ trust in the projects’ PoR is key to their longevity.
3. 2. Build a secure and healthy crypto trading ecosystem
4. PoR is vital in ensuring a safe and reliable environment for value exchange in the crypto world. Exchanges’ regular disclosure of their reserves can enhance the transparency of crypto trading while helping market participants make more informed trading decisions and cut unnecessary losses.

How does Proof of Reserves work?

Reserves can be verified through two methods. First, independent audits conducted by third parties. Such evaluation helps ensure that projects’ reserves match the amount they claim to hold. This process utilizes an advanced encryption program based on Merkle Tree, a data structure explicitly designed to ensure privacy and, in particular, strengthen the transparency and security of crypto exchange.

The second method for demonstrating reserves is through public addresses. By publicly publishing all addresses holding reserve currency, exchanges can show that their liquidity claims are factual. While audits provide more concrete evidence, anyone can utilize the public address option to verify the reserve status of a particular exchange or project.

What institutions/exchanges in the crypto market use Proof of Reserves?

Following the collapse of FTX, some centralized exchanges offered to provide users with facilities, that is, a Proof of Reserves (PoR) system, to verify the status of asset holdings on their platforms and ensure that users can redeem their assets anytime.

Exchanges that currently use PoR include Kraken, Coinfloor, Gate.io, BitMex, HBTC and Ledn. Kraken and Gate.io use auditor-assisted user verification through the Merkel tree method, while Coinfloor, HBTC and BitMex conduct self-evaluation and user verification with the Merkel tree. Many centralized exchanges such as Binance, OKX, Kucoin, Huobin, and Crypto.com have all published their Proof of Reserves. The use of PoR enables these crypto exchanges to provide clients with greater security and win their trust.

In addition to these centralized exchanges, some crypto trading platforms have also rolled out PoR tools to enable users to view reserves data. For example, CoinGecko’s reserve data and Nansen’s Asset/Net Worth Dashboard allow users to obtain and track the finances of exchanges. Chainlink’s PoR provides needed data for smart contracts to calculate the cross-chain or off-chain collateral ratio of any on-chain assets. It is worth mentioning that TUSD works with Chainlink, a leading provider of secure and reliable open-source oracle solutions, to record the audited data on the chain. Once the PoR contract warns that the USD in reserve is lower than TUSD’s supply, a meltdown mechanism will be triggered to stop minting. Also, any platform can access the data of TUSD’s reserves through its API interface. These measures safeguard the users’ assets and make TUSD the first USD-backed stablecoin that provides real-time on-chain audit.

Proof of Reserves is key to the transparency and security of cryptocurrency trading. All crypto investors are advised to use PoR to make informed investment decisions.

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