Giottus Technologies, one of the top-5 cryptocurrency exchanges in India has announced that it will provide customers with proof of reserves (PoR). The company’s willingness to make public its proof of reserves has already created a flutter in crypto circles.
In a statement released on November 11, four days ahead of its fifth anniversary, Giottus CEO Vikram Subburaj said the company was ready to go ahead and publicise its PoR. Earlier, he had said the same in an interview with Coindesk.com.
Many prominent centralized exchanges such as Binance, Gate.io, KuCoin, Poloniex, MEXC Global, Bitget, Huobi, OKX, Deribit, Giottus, and Bybit have all announced to publicly provide their Merkle Tree reserve certificates in an effort to encourage further transparency.
Vikram’s statement assumes significance in the wake of the shocking collapse of the crypto giant FTX that had rocked the industry in the recent past after the cryptocurrency exchange Binance decided to back out of its move to acquire rival FTX.
So, what is this controversial proof of reserves and why is it wise for companies to publicize it?
Proof of reserves seeks to conduct an impartial audit by a third party of the exchange’s reserves to verify the accuracy of customer balances maintained by the custodian. This can be compared to the cash reserve ratio that banks maintain with the RBI.
Here, the auditor takes an anonymized image of all balances and aggregates them into a Merkle tree, a privacy-friendly data structure encapsulating all customer balances. The Merkle tree consolidates all transaction data to date.
The Merkle tree proof of reserves, named after its inventor Ralph Merkle, is a cryptographic tool at the heart of all blockchain technology. It’s a cryptographic mathematical data structure that maintains privacy but allows users to verify the stability of their holdings on exchanges.
The auditor derives a Merkle root from the Merkle tree, which is a cryptographic fingerprint that specifically identifies the combination of these balances at the moment the image was made.
Why is PoR important?
PoR is a much-needed verification method to support transparency and security in the crypto domain, as the crypto sector continues to grow.
Proof of Reserves is a trusted way for customers to verify that the balances they hold on to crypto exchanges are backed by real assets. Exchanges will exercise greater caution when selecting unwise fund exposures. It also lets the customer make informed choices before trusting an exchange.
It not only helps improve quality and transparency but also acts as a critical safeguard against different security risks that are commonly encountered in the industry.
This raises the question of what resources can be considered reserves.
The assets that can be considered reserves must have a strong liquidity profile. In case of a crisis, the exchange and its clients could quickly sell the assets. Therefore, a significant component of the exchange’s portfolio must consist of hard, highly liquid assets.
Bitcoin (BTC), Ethereum (ETH), and stablecoins such as tether (USDT), USD coin (USDC), Binance USD (BUSD), and dai (DAI) can be considered good reserves.
Proof of Reserves benefits the public sector, the business community, and the general public.
Audits of Proof of Reserves are advantageous to both users and custodians. The custodians gain the trust of their users, which aids in user retention, while consumers acquire a powerful tool to audit digital asset reserves.
However, the critical aspect of this process is the initial image and if an exchange borrows funds temporarily before the image, it might be assumed that they are solvent and able to pay for user fund withdrawals. There are also widespread concerns over the expertise in conducting the audit. There are other worries about the audit’s competency as well. The goal of proof of reserve would be defeated if the audit firm is unable to comprehend how the exchange has organized the client’s assets.
What is a proof-of-reserves attestation?
A PoR attestation is a real-time or periodic review of balances held by a centralized cryptocurrency exchange or lending platform. A third-party accounting firm often provides the attestation with Armanino being the leading auditor for most crypto service providers.
Real-time attestation offers insights that are updated multiple times each day. On the other hand, a periodic attestation is released on a schedule that the custodian specifies, such as every month, quarter, or year.
PoR is an intriguing prospect for regulators as this self-regulating approach is in accordance with their broad strategy for the business. In a nutshell, the use of Proof of Reserve (PoR) helps crypto exchanges to provide more security to their customers and help gain their trust.
