David – Cryptocurrency Expert
The term Proof of Reserve is a popular topic right now due to recent cryptocurrency exchange events. Binance CEO Changpeng Zhao recently said “all crypto exchanges should do Merkle-tree proof-of-reserves. Banks run on fractional reserves, Crypto exchanges should not. Binance will start to do proof-of-reserves soon. Full transparency.”
Proof of Reserve, or PoR, is an auditing procedure that can be independently verified and adds to the transparency of centrally controlled cryptocurrency reserves. PoR examines the validity of public wallet entries, conducts frequent third-party audits, and uses cryptographic proofs to validate the fund reserves of a centralised platform. Customers can use this information to assess the platform's financial stability and the likelihood that customer deposits will be matched. PoR uses blockchain technology, but it still depends on the correctness of the accounting procedures and the evaluation of off-chain assets.
Proof of reserves (PoR) is a third-party independent audit that verifies a custodian legitimately has the assets it claims to have in possession of its clients. Using an anonymous snapshot of all balances, this auditor organises all held balances into a Merkle tree.
A Merkle is a cryptographic commitment technique that is known for identifying the cryptographic hash of each "leaf" or node. They are mostly employed to examine information that has been handled, sent, or saved between computers. Even though the concept was developed in 1979, peer-to-peer blockchain networks still frequently employ it.
The auditor next acquires a Merkle root, a cryptographic fingerprint that may be used to pinpoint the precise order of these balances at the moment the snapshot was taken.
After that, the auditor collects digital signatures made by the cryptocurrency exchange that confirm who is in charge of on-chain addresses with visible balances. The auditor then compares these balances to the client balances displayed in the Merkle tree and determines whether they are higher or equal to those amounts.
Many in the cryptocurrency industry commended the PoR method for making sense and appearing to be a step toward a more transparent crypto market. Centralized exchanges can record each account's liabilities using transaction records and details about the assets stored. They would have to publish with a tag that only their account owners are aware of to keep their anonymity.
In general, PoR goal is to make sure that exchange platforms don’t act in any fraudulent activity linked to any of their customer's money. Cryptocurrency investment and trading cryptocurrency slowed down due to recent crypto events. Even that said, some of the exchanges trying to prove to the customers that they are implementing full transparency and being honest. In the end, the only thing that matters for the customers is the safety of their crypto assets and coin holdings.