Proof of Reserve

Introduction

Crypto exchanges and trading platforms’ financial transactions are encouraged and assisted via different blockchain-based cryptographic proofs. Proof-of-reserve is one of the cryptographic proofs that further adds a layer of transparency by setting up an authorized framework for auditing crypto exchanges and platforms.

What is Proof-of-reserve?

An auditing method through which a crypto trading platform or a crypto exchange proves they have the amount of crypto assets that they claim to have. A practice that addresses the transparency issues of assets stored in a crypto exchange. An essential inspecting technique that ensures the real assets are stored in a decentralized crypto exchange.

Proof of reserves refers to a particular pre-defined assessment where trusted third-party auditors conduct auditing of statements of blockchain-based projects. It brings out a clear picture of the reserves (stored assets) held by the crypto exchange, thus, improving trust and transparency in the industry. It is a way through which participants of the platforms can hold platforms accountable for the funds. It also offers information to users of the platforms about their funds and their liabilities.

Importance of PoR

• In-depth study of the total assets held by crypto platforms.
• A piece of complete knowledge about individual users’ share of assets.
• PoR offers transparency in asset management
• It offers privacy and trust to customer
• It showcases actual records of an institution

What happens when PoR commitment is not followed by an institution?

• The assets of the customers stored by the crypto exchange are at risk.
• There can be delays or negligence in cashing out assets by the users.
• Such crypto exchanges or platforms are prone to bankruptcy.

The working mechanism of PoR

PoR is a mechanism by which the balance sheets of a crypto exchange are verified. In this process, it is checked if the custodians have enough balance of the customer holdings. The lawful usage of customers' holdings including real assets backed by cryptos is also checked. The DeFi ecosystem is given security and privacy as the third-party audit team’s reports are cryptographically reconciled. And, this process of auditing is using the Merkle Tree technique.

Merkle Tree technique

Invented by Ralph C. Merkle, the Merkle tree audit methodology is used to store data/information safely and accurately. A process in which data is structured in such a way that it eases attempts to access data and supports its verification.

• Data is divided into smaller parts that can be analyzed easily without passing through the main data branch. Here, definite data are mixed into autonomous branches but cross over to a single root, known as the Merkle root.
• Merkle root is responsible for storing correct data in each data branch, as it is the only point of connection to verify the whole data tree. It also ensures uniformity of data security, where data can not be altered or destroyed.
• In blockchain networks, the Merkle tree serves as the primary data management technique, and a key building block to direct the amplifying amount of data its participants will produce.
• Each block handled out to the chain is acknowledged by a hash, where the Merkle tree provides a storage and identification system. This safeguards the data as per their hash. Thus, the data in the block confirms the hash negating the need to work out the entire network’s blocks.
• The immutable, permanent, and transparent ledger is recorded that can be checked and verified by all the stakeholders involved in a transaction.
• The PoR represents a platform’s assets and liabilities on-chain in a miniature Merkle tree. The third-party auditor creates a regular record of the assets held in custody by a platform before analyzing the records.

Conclusion

Proof of Reserve is an audit method conducted by a trusted third party to prove the crypto assets hold by a crypto exchange. It is an audit method that improves transparency and trust among platform participants, regulators, and investors. It also helps in building brand value. If you need need to know more about Proof of Reserve, and how it can help your DeFi platform, connect with Nu10’s blockchain experts and strategists.