Proof of Reserves: Can Reserve Audits Avoid Another FTX-like Moment?
Crypto Exchanges Are Actively Publishing Proof of Reserve Audits to Boost Transparency, But Experts Say More is Needed to regain investor confidence.
Following the collapse of FTX that occurred following the bankruptcy of the cryptocurrency exchange that funnels user funds to mitigate its own risk, crypto exchanges came up with a transparency solution called proof of reserves.
A practice, which was recently endorsed by Binance CEO Changpeng Zhao, provides a way for exchanges to show that they offer transparency to users in the absence of clear regulations.
All crypto exchanges must do merkle-tree reserve proof.
Banks operate on fractional reserves. Crypto exchanges shouldn't. @Binance will soon start making reserve proofs. Total transparency.
— CZ Binance (@cz_binance) November 8, 2022Proof of Reserves (PoR) is an independent third-party audit to ensure that a custodian holds the assets it claims to hold on behalf of its clients.
This auditor takes an anonymized snapshot of all held balances and aggregates them into a Merkle tree.
A Merkle is a cryptographic commitment scheme in which each "leaf", or node, is tagged with the cryptographic hash of a block of data. Their main use is to verify data that has been manipulated, sent or stored between computers. Although invented in 1979, the concept has been widely used in peer-to-peer blockchain networks.
After taking the snapshot, the auditor gets a Merkle root: a cryptographic fingerprint that uniquely identifies the combination of these balances at the time the snapshot was created.
The auditor then collects the digital signatures produced by the crypto exchange, which prove ownership of the on-chain addresses with publicly verifiable balances. Finally, the auditor compares and verifies that these balances exceed or match the customer balances represented in the Merkle tree so that customer assets are held on a full reserve basis.
A total of five centralized exchanges...
Crypto Exchanges Are Actively Publishing Proof of Reserve Audits to Boost Transparency, But Experts Say More is Needed to regain investor confidence.
Following the collapse of FTX that occurred following the bankruptcy of the cryptocurrency exchange that funnels user funds to mitigate its own risk, crypto exchanges came up with a transparency solution called proof of reserves.
A practice, which was recently endorsed by Binance CEO Changpeng Zhao, provides a way for exchanges to show that they offer transparency to users in the absence of clear regulations.
All crypto exchanges must do merkle-tree reserve proof.
Banks operate on fractional reserves. Crypto exchanges shouldn't. @Binance will soon start making reserve proofs. Total transparency.
— CZ Binance (@cz_binance) November 8, 2022Proof of Reserves (PoR) is an independent third-party audit to ensure that a custodian holds the assets it claims to hold on behalf of its clients.
This auditor takes an anonymized snapshot of all held balances and aggregates them into a Merkle tree.
A Merkle is a cryptographic commitment scheme in which each "leaf", or node, is tagged with the cryptographic hash of a block of data. Their main use is to verify data that has been manipulated, sent or stored between computers. Although invented in 1979, the concept has been widely used in peer-to-peer blockchain networks.
After taking the snapshot, the auditor gets a Merkle root: a cryptographic fingerprint that uniquely identifies the combination of these balances at the time the snapshot was created.
The auditor then collects the digital signatures produced by the crypto exchange, which prove ownership of the on-chain addresses with publicly verifiable balances. Finally, the auditor compares and verifies that these balances exceed or match the customer balances represented in the Merkle tree so that customer assets are held on a full reserve basis.
A total of five centralized exchanges...
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