Understanding the Functions and Limitations of Proof of Reserves

Key Insights

• Proof of Reserves (PoR) is a process in which a centralized cryptoasset custodian transparently shows that its cryptoassets held on deposit match with user deposits.
• PoR shouldn’t be equated with a more rigorous “Proof of Solvency.”
• Current PoR assessments do not come without challenges of their own. However, the practice is a step in the right direction for the crypto industry as a whole.

In the wake of the FTX Group’s fallout, centralized crypto custodians are facing pressure to shed light on their historically opaque balance sheets. Investors, users, and general market participants are demanding to see evidence that the assets held by custodians exceed the liabilities owed to their depositing customers. This has sparked a renewed interest in Proof of Reserves (PoR) — the idea that custodians must be able to prove that they are indeed holding the assets that their clients have entrusted them with.

On the surface, the concept of PoR appears to be a silver bullet to hold custodians accountable to both their depositors and the wider crypto industry. Just aggregate the on-chain assets, subtract customer liabilities, and determine if the custodian can meet its depositors’ demands. However, this is an oversimplified view that creates widespread confusion as to the scope of PoR and its limitations.

Defining Proof of Reserves