Proof of Reserves (PoR) is a method crypto firms use to provide transparent auditing. This practice aims to objectively evaluate the assets held by the company as reserves. To ensure accuracy, third-party auditors carefully examine cryptographic signatures that indicate the total balance of client assets. They also verify that these assets’ custodians hold an equal or greater amount of reserve assets to cover potential customer withdrawals.
The purpose of PoR is to instil confidence in consumers. It demonstrates that the crypto firm is financially stable and has sufficient liquidity. This means that if customers decide to withdraw their money, the funds are readily available. With this solution, cryptocurrency firms can assure their users regarding the safety and accessibility of their funds.
The audit process can be divided into three main stages:
- Proof of liabilities involves calculating the total amount of cryptocurrency owed by exchange customers. This information is then compared to the total reserves held by the exchange to assess solvency.
- Proof of reserves is a process where the exchange adds up the balances of the crypto addresses for which it holds the private keys. By providing the public key and signing it with the private key, the exchange can demonstrate that it is the legitimate owner of the crypto addresses.
- Proof of solvency involves conducting an audit and providing an attestation to validate that the auditing software was run in a trustworthy environment. The audit result is either true or false, indicating whether the reserves outweigh the obligations. The attestation acts as a signature for the program hashes and platform measurements, ensuring that the computation considers the account balances of consumers.
Bottom Line
In light of the FTX crypto exchange collapse and recent statements from Binance emphasizing the importance of transparency, proof of reserves is gaining popularity. It will become increasingly vital as regulators aim to establish industry standards for consumer protection.
