Proof of Reserves

Published: Feb 13, 2023 Est. read time: 1 minute

What is a 'Proof of Reserve'?

Proof of reserves is a way for exchanges to cryptographically prove they hold the assets they claim they do. In addition, some exchanges go slightly further and also offer the ability for you to verify your own assets.

How can we trust what exchanges publish as their proof of reserves?

Traditionally a reputable external audit company can back up the claims made however this is still a very traditional centralized approach that relies on trust. There is however a technical verifiable approach that some exchanges provide called a Merkle Tree.

Merkle trees (also known as hash trees or binary hash trees) are a type of data structure used in computer science. They allow verification of large datasets and are being used by exchanges to reveal the exact amounts of each cryptocurrency that it holds whilst not disclosing user holdings.

What are the limitations of 'proof of reserves'?

The largest criticism of proof of reserves is that they don't paint the complete picture and in particular don't detail what liability they have. Therefore doesn't prove if an exchange is actually solvent.

Overall, it's a step in the right and provides much-needed transparency to regain investors' trust again. It should not be used exclusively to determine whether an exchange is financially solvent.