The idea of “proof of reserves” is relatively new in the world of crypto and has come as a response to the financial issues surrounding crypto exchanges like FTX, BlockFi, and others. The idea is that crypto companies inspire confidence in investors by revealing their reserves, but there are more than a few people who question the relevancy of this act.
Should crypto companies reveal their proof of reserves? And moreover, does it actually mean the crypto exchange is in good health?
What Is Happening in Crypto?
First, Coindesk released the Alameda Research balance sheet, revealing FTX’s internal problems, prompting many investors to withdraw their FTT holdings. Not long after, Binance announced it was liquidating $2 billion worth of FTT, which made many more investors sell their FTT tokens out of panic. Those two events marked the beginning of the end of FTX, one of the world’s largest cryptocurrency exchanges in terms of trade volume.
The massive negative sentiment towards FTT also affected BlockFi. The exchange had a lot of exposure to the FTT token, and the heavy hit forced BlockFi to stop processing withdrawals. There are rumors that the company is also on the brink of bankruptcy.
Why Are Crypto Exchanges Revealing Their Proof of Reserves?
In a bid to restore investor confidence in cryptocurrency, the idea of “proof of reserves” started becoming a big deal. Proof of reserves is seen as a way for exchanges to assure customers that they are in fine shape and won’t meet the same fate as the defunct FTX.
Crypto.com gave a brief look into its books to show partial proof of funds to give people an idea of what the company reserve is like and to reduce panic in the crypto industry, especially among its users. The company also promised to provide a fully audited report in a few weeks.
Coinbase CEO Brian Armstrong tweeted that his company does not use customer money for any other purpose except as directed by the customers. It also has a backup fund for every customer’s fund.
Binance CEO Changpeng Zhao also agreed to the idea of providing proof of reserve as Binance shared the addresses of its hot and cold wallets for some of its holdings, promising to give a fully audited report.
Bybit also carried out similar actions to ease the built tension. In addition, more crypto exchanges have mentioned that they are working to carry out standard and detailed proof of research.
What Is a Proof of Reserves Audit?
Proof of reserves attempts to make crypto exchanges’ reserves publicly transparent by carrying out auditing practices. The audit is carried out by third parties on crypto exchanges to confirm that they have the money they claim to store for customer protection.
The idea came as a way of ensuring transparency for crypto exchanges. It will let investors know they have a reserve for each deposit and their funds are not used for any form of investment or other purposes.
Many crypto users have lauded the PoR practice, which looks like a major step toward ensuring transparency. However, there are still concerns that exchanges may be faking their reserves by obtaining money to show as reserves and moving the fund after the audit.
In addition, there are no standard rules that guide what a proper PoR procedure should look like, meaning that the practice is only as reliable as the exchanges and auditors carrying it out. Furthermore, at least at the time of publishing, very few companies have undergone a third-party audit. As Coinbase is a publicly tradable stock, it is one of the only companies that has undergone extensive auditing, which is one of the reasons it remains one of the best crypto exchanges.
The Significance of Proof of Reserves
Proof of reserves will benefit the crypto industry in the following ways:
Revealing proof of reserves will ensure crypto exchange services are fully transparent. Exchanges won’t be able to carry out transactions with their client’s money, reducing the risk of insolvency.
Since the proof of reserve audit provides a complete and transparent picture of the amount of crypto in an exchange’s reserve, We also expect it to give crypto users and intending users more trust in cryptocurrency exchanges.
Proof of Reserves Could Become an Established Practice
The PoR became more popular recently and is not yet a general standard in the crypto industry. However, since industry leaders like Binance, Bybit, and Crypto.com are taking up the process, it could become a standard practice for crypto exchanges to establish trust or at least increase investors’ confidence in cryptocurrency usage, especially at this trying time.