How Does Proof of Reserves Work?
Proof of Reserves is a method of proving that a cryptocurrency firm holds sufficient assets to collateralize its outstanding liabilities.
A crypto exchange that does not publish any proof of their reserves is asking their customers to trust them, which goes against the “don’t trust, verify” ethos of cryptocurrency.
Proof of Reserves is critical for issuers of stablecoins and wrapped tokens. Users want a guarantee that their stablecoins and wrapped tokens are backed by assets to which they are pegged and held in reserve.
A Merkle tree is one way to execute a Proof of Reserves attestation. It’s a cryptographic method of consolidating large amounts of data into a single hash.
The Merkle tree Proof of Reserves protocol verifies the validity of user balances and transactions. It hides the exact amounts of each cryptocurrency that the exchange holds to protect the privacy of the platform and its users.
Crypto exchanges may publish Merkle tree-based Proof of Reserves attestations on a weekly, monthly, or quarterly basis, in the form of snapshots.
Some firms might provide real-time attestations. If a company publishes Proof of Reserves, customers gain a level of assurance that their deposits are safely held and can be withdrawn at any time.
It’s also a crypto-native approach that allows companies to gain trust through self-regulation.
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