Ever heard of the phrase: Trust, but verify? Proof-Of-Reserve’s saying is: Don’t Trust, Verify.
When writing this Crypto 101 content, it’s November 2022. Unfortunately, 2022 has been one of the worst – if not the worst – years for cryptocurrencies from any fundamental or technical measurement.
FTX’s bankruptcy in late 2022 added to an already big list of entities in the cryptocurrency space that collapsed: hedge fun Three Arrows Capital (3AC), crypto lending platform Celsius ($CEL.X), and crypto exchange Voyager ($VGX.X)are just some of the entities that fell in 2022.
To summarize, FTX, Celsius, and other entities lent out customers’ crypto assets to other firms. But, when those firms collapsed, many customers who believed their safe assets were gone – possibly forever.
Trust in cryptocurrency exchanges, wallets, and other custody forms dropped to levels beyond the loss of trust during Mt. Gox.
Proof of Reserves + Proof of Liability = Verified Solvency
Proof-Of-Reserves is a claim (attestation) from an exchange that says they have your crypto; it’s still there and hasn’t been used or sent elsewhere.
Ok, but how do you prove that? Taking an exchange’s word that your funds are ‘safu’ hasn’t worked – so how can someone know an exchange is being honest?
The first method is the old-fashioned way: use an accounting firm to perform an audit. For example, the Crypto lending platform Nexo ($NEXO.X) uses the accounting firm Aramino.
But then we ask, “but how do we trust the accounting firm?” Good question – Aramino is in the Top 25 accounting firms in the U.S. and has been around since the 1950s; the rest of the determination of their honesty is up to you.
Another method of showing Proof-Of-Reserves is using a trusted on-chain analytics service like Nansen.
Merkle trees are also used, but there’s no great way to properly summarize a Merkle tree in this article – look for that in a future Crypto 101 article. But in a nutshell, a Merkle tree on a blockchain ensures that blocks (data) sent and received are unaltered and original. It also acts as a way to prevent any fake data and manipulated data.
Who Has Completed Proof-Of-Reserves?
The entities listed below include but are not limited to the listed entities.
So far, Kraken, BitMex, Nexo, Gate.io, and HBTC have completed a full Proof-Of-Reserve release.
Binance, Bitfinex, Crypto.com, KuCoin, OKEx, and Huobi have committed to providing a full Proof-Of-Reserve release very soon. 👨⚖️