What is Proof of Reserves and why is it important?
In the wake of the FTX collapse, many platforms, including Binance and KuCoin, are falling over each other to announce their Proof of Reserves status and so reassure us that our funds are safe with them.
But what is Proof of Reserves?
Let me explain in a simple, easy to understand way:
Proof-of-reserves are independent audits by third parties that aim to provide transparency and evidence that a custodian holds the assets it claims to own on behalf of its clients.
Auditors then aggregate balances into something called a Merkle tree, (also known as binary hash trees), which is a cryptographic tool that helps create a summary of funds held in an exchange’s wallets and generates a proof that can be verified on-chain, all without exposing sensitive customer information.
FTX imploded this week following a CoinDesk report which showed the June balance sheet of its affiliate trading firm, Alameda Research, was mostly made up of FTX’s native token, FTT.
Therefore FTX was using a token, which they created, as collateral. Unwise in the extreme, as FTX soon discovered.
Proof of Reserves is a step up from reserve attestations or real-time audits, which you will see used with Nexo or Kraken.
But hopefully either or both of these initiatives will bring about greater customer protection and transparency in the industry.
DBM Academy Founder Coach
Find me at Defiantly Digital