The collapse of crypto exchanges like FTX may have given birth to the idiom "Proof of Reserve," the latest crypto jargon to be added to a list of many unique terminologies already in use in the industry.
Binance CEO Changpeng Zhao recently announced that Binance would start implementing proof-of-reserve soon. So, what is proof-of-reserve and why is it important for investors?
Proof-Of-Reserve
Proof of Reserve or PoR is a verifiable auditing procedure that helps enhance transparency to centralised cryptocurrency reserves. PoR uses cryptographic proofs, checks the ownership of public wallet addresses, and recurring third-party audits to certify a centralised platform’s fund reserves.
It helps customers understand about the platform’s financial position and whether it has adequate funds to match customer deposits. Users can also check account balance using the cryptographic method.
According to CoinDCX, a crypto exchange, a PoR audit is a third party crypto auditor employed by an exchange to ensure it assets on the balance sheet are balanced the customer holdings. It is done using the ‘Merkle Tree’ technique in a cryptographic process, it said in a statement.
Although PoR uses the blockchain technology, it still depends on the accuracy of the accounting procedures and the valuation of off-chain assets.
RoR offers customers more security to their assets. It is the only tool through which the unregulated and unlicensed exchanges can prove everything is in order.
"Customers should only work with regulated and licensed companies or one showing proof of reserve. A few companies, which have the license, are Coinbase and Kraken in the US. Yield wallets that are licensed are Cashaa, Swissborg, and Nexo in Europe,” says Kumar Gaurav, founder & CEO of Cashaa, wallet provider. But platforms, like Binance and Kucoin, which are not licensed for their entire operations, use RoR to win customers’ trust, Gaurav added.
PoR Gives Confidence To Investors
Several crypto exchanges have audited their proof of reserves recently, showing their intention to promote customers’ confidence and increase transparency.
The exchanges that conducted RoR audits recently included Huobi, Binance, Crypto.com, Deribit, KuCoin, OkxKraken, BitMEX, CoinfloorGate.io, and Giottus, an Indian crypto exchange.
A RoR can help validate the transaction’s integrity by auditing chain’s hash from Merkle Root for independent auditors like Hacken.io.
The above entities have already agreed to “publish their cold wallet address,” which is a must, says Mohamed Mustafa Saidalavi, a certified Web3, Blockchain, NFT, and Metaverse expert.
Saidalavi noted that regulators play a vital role in developing and enforcing standards for crypto exchange and DeFi platforms, besides creating audit systems based on the Autonomous Decentralised Organization (DAO). He advised Indian investors to be extra careful and ensure the exchange has a cold wallet address from Merkle-root and runs on a proof-of-reserve consensus algorithm.
Is Proof Of Reserve A Lasting Solution?
Most experts have opined that PoR is a step forward but not a lasting solution. People still have to trust the exchange’s security protocols and wallet addresses. "Investors also have to realise that if they wish to protect their funds, they'll have to control the private keys of their digital assets. “They can't trust an exchange or a 3rd party wallet. The volatile nature of digital assets can make even the most trusted exchanges fall," says Mohammed Roshan, CEO and co-founder of GoSats, a crypto platform.
Red Flag For PoR
Many centralised exchanges support PoR or provide PoR audit data. However, there is still a problem in shifting their cash after an audit snapshot.
After publishing its PoR audit, Crypto.com recently sent 280,000 Ether tokens to a Gate.io address, sparking speculation that cryptocurrency exchanges may be fabricating their reserve audits. In addition, numerous cryptocurrency community members alleged that exchanges were borrowing assets to portray a robust financial book but immediately returned them after the snapshot.
More questions were raised when Crypto.com CEO Kris Marszalek publicly said that the $400 million ETH transfer was an error and was intended for another cold wallet.
"An audit by an appropriate third-party agency can give strong credibility to an exchange and regain trust in the investor community. Moreover, if the governments proactively set up agencies equipped to do audits, it will "make the process even smoother," says Vikram Subburaj, the CEO of the Giottus crypto platform
