Since cryptocurrencies found tangible use through exchange platforms, there have been instances of crypto exchange ventures failing miserably and getting bankrupt for a variety of reasons. Mt.Gox, Quadriga, and recently, FTX have been unable to maintain investor funds securely, resulting in the loss of trust and ultimately shutting down operations. There have been voices from around the crypto community for some kind of independent audit mechanism to be brought to avoid such instances. And, Proof-of-Reserves could be the ideal solution implemented currently by many exchange ventures. We will see in detail the latest fund verification mechanism in this blog.
Proof-of-Reserves: A View from Above
Proof-of-Reserves (PoR) is the latest proving mechanism utilized to verify that a crypto exchange has all investors’ funds through independent audits. These checks can be executed for off-chain and cross-chain assets, ensuring crypto exchange ventures gain trust among investors by being transparent with asset management.
The process makes use of data structures called Merkle Trees that utilize data hashes to verify transaction data in the cryptographical domain efficiently. The mechanism allows transparency and trust in crypto exchanges to be instilled in the crypto community. According to industry experts, PoR could become mainstream in 2023, as many centralized crypto finance institutions utilize the mechanism.
But, Why is It only CeFi that Uses PoR?
The mechanism to prove crypto reserves is valid for centralized crypto finance (CeFi) institutions. While the current trends might put such perspectives in the limelight, it is true this time around. The reason being decentralized crypto finance (DeFi) institutions rely on smart contracts for transactions, and no authority can touch investor funds without consensus approval. In the case of CeFi, funds could (and were) transferred to be used for different purposes, including lending and risky investments. But, DeFi ventures can make use of the mechanism in a slightly different way, which we will see later in the blog.
Advantages of Utilizing PoR for the Crypto World
- The PoR mechanism benefits the public crypto space by maintaining transparency and trust in crypto institutions which might not be possible through using simple cash flow analysis and point-in-time attestations.
- These reserve-proving audits benefit both investors and institutions. For crypto investors, these prove to be powerful tools to verify digital asset reserves. On the other hand, crypto ventures can benefit from the trust these audits offer, helping them retain their user bases.
- Additionally, the mechanism can be favored by governmental regulatory authorities, as it offers a way for self-regulation, erasing regulators’ skepticism in cryptocurrencies and easing their investigative duties.
The Technical Process of Proving Crypto Reserves
- Before starting, one should note that the process involves third-party crypto auditors hired by the crypto exchange venture to check their asset reserves.
- Firstly, the external crypto auditor collects the data of all balances in the exchange’s reserves and wallets in the form of a Merkle Tree.
- Then, the Merkle Root is obtained that finds and adds up the sum of balances of all accounts of the platform.
- The balances obtained from the Merkle Root are verified on the public blockchain, where the exchange rests on using the digital signatures given by the platform venture.
- The auditor checks the balance data obtained earlier and the asset details available on the public blockchain network. These values should ideally match, making sure that transparency is maintained.
- On the other hand, customers can also check whether sufficient funds are available in the reserves through systems set up by the exchange that update the PoR audit regularly.
- If there is a change in data, the Merkle Root will be affected, making it clear that tampering of some form has been performed on the assets.
Use Cases of the PoR Mechanism
- Digitized Assets, such as Central Bank Digital Currencies (CBDCs), stablecoins, and wrapped cryptocurrencies, can be easily backed using the PoR audit mechanism.
- Financial Applications running on-chain, including crypto exchanges and lending platforms, can utilize the mechanism to earn user trust.
- Circuit Breakers in crypto financial ventures created using the reserve proving mechanism can be used to avoid under-collateralization of a venture’s reserve assets.
- Cross-chain Tokenization becomes easier with PoR audits as data on assets on any blockchain can be obtained quickly.
End-users Gaining Immensely from Automated Reserve Proving Audits
- Crypto Asset Issuers for off-chain and cross-chain assets can utilize the proving mechanism to ensure that token minting does not go overboard to prevent inflation of token value.
- DeFi Application Ventures can use these crypto audits as circuit breakers to avoid under-collateralization in case unbacked tokens are minted by platform users.
- DeFi Users also can benefit from the mechanism as a way to ensure their in-platform crypto wallets are taken into account while auditing the platform’s reserves to ensure transparency.
- CeFi Users can similarly ensure that enough assets are present in the platforms’ reserves, instilling trust as a result.
How can Blockchain App Factory Assist You with Crypto Reserve-checking Audits?
Blockchain App Factory has been a world-class Web3 service provider with a wide range of capabilities. Our ever-evolving skillsets now have a new one, namely Proof-of-Reserves audits. We can help your venture verify your crypto reserves and show them to users, increasing trust and accomplishing transparency in the process. There are many reasons to choose us for your work apart from this, including:
- Proficient Blockchain Developers
- Seasoned Teams in End-to-End Software Development
- Creative Consultant Team
- Customizable Solutions
- Multi-chain Compatibility
- Anytime Support in Technical and Non-technical Domains
- On-time Delivery
- Competitive Pricing
Fill out the inquiry form below to get started by interacting with one of our experts to conduct a PoR audit for your crypto business