How Proof of Reserves Audits Work: A Complete Guide

As the popularity of cryptocurrencies continues to grow, ensuring the security of customer funds has become crucial. Proof of Reserves (PoR) audits provide transparency and verification of a platform's solvency. This guide will explore PoR audits, their differences from Proof of Solvency (PoS), and how they work to guarantee the safety of user funds.

Is a major crypto exchange solvent?

A major cryptocurrency exchange claims to be 100% solvent and has developed a method for customers to verify this claim independently. Their PoR audits include reserve ratios, demonstrating that customer funds are backed by more than 100% in reserves. This exchange publishes monthly PoR audits and has developed an open-source function allowing users to verify solvency on-chain.

What are the current reserve ratios?

The exchange calculates its reserve ratios using the formula: (Amount of [asset] / Amount of [asset] held by users) * 100. The platform provides current reserve ratios for major cryptocurrencies like Bitcoin, Ethereum, and stablecoins.

What's the difference between proof of reserves and proof of solvency?

While often confused, PoR and PoS are distinct concepts:

• PoR demonstrates that a custodian has the assets it claims to have.
• Proof of Liabilities (PoL) proves the total assets a custodian owes its customers.
• Proof of Solvency shows that a custodian has sufficient assets to pay all its customers.

Reserve ratios offer proof of solvency by demonstrating that the platform has more assets than it owes to its customers.

What are the exchange's reserves?

The exchange claims to have clean reserves, with high-quality assets representing over 92% of holdings. The platform also states that the majority of its reserves have remained unmoved for several years, stored in cold storage for maximum security.

How to verify reserves

Customers can verify their holdings through:

1. The exchange's self-audit tool
2. Third-party tools for verifying signatures on various blockchains

How does the PoR process work?

The exchange uses Merkle sum trees to demonstrate its reserves. This cryptographic method allows millions of users to quickly verify reserves themselves. The process involves creating a snapshot of all eligible user accounts and assigning each a unique anonymous user hash ID. The total balance of each user's assets becomes a "Merkle leaf" in the tree, with the sum of all user assets creating a "Merkle root."

What else is being done to increase transparency?

In addition to monthly PoR and liability proofs, the exchange commits to:

• Third-party audits
• Continuous improvement of global compliance programs
• Obtaining licenses where appropriate
• Maintaining strong financial balance with zero external debt
• Never using customer funds without explicit consent
• Maintaining effective risk management systems

How to verify solvency yourself

Users can verify solvency in two steps:

1. Verify if their assets are included in the exchange's Merkle tree
2. Verify that the exchange's total customer liabilities match its holdings

The guide provides detailed steps for users to perform this verification process using the exchange's tools and open-source Merkle Validator.

Conclusion

Proof of Reserves audits play a crucial role in ensuring transparency and security in the cryptocurrency ecosystem. By understanding how PoR works and utilizing the tools provided by cryptocurrency platforms, users can make informed decisions and prioritize their security when using these services. As the industry continues to evolve, it is likely that PoR audits and similar transparency measures will become standard practice, further enhancing trust and reliability in the crypto space.

FAQ

Can the government see how much crypto I have?

Generally, no. Cryptocurrencies offer pseudonymity, but not complete anonymity. While transactions are public, they're not directly linked to personal identities. However, governments can potentially trace holdings through exchanges or blockchain analysis.

Do you have to report crypto under $600 in the USA?

Generally, no. The IRS requires reporting of crypto transactions over $600. Smaller amounts typically don't need to be reported, but it's advisable to keep records of all transactions.

Can I use crypto as proof of funds?

Yes, many institutions now accept cryptocurrency as proof of funds. However, specific requirements may vary, so it's best to check with the entity requesting proof.