Proof of Reserves Progresses, But Regulatory Hurdles Remain

Key Points:

Proof of reserves is becoming more effective thanks to technical advances.
However, regulatory and compliance issues also need to be addressed.
Centralized and decentralized platforms present different challenges for PoR.

2 - 3 minute read

Proof of reserves (PoR) is becoming an increasingly important topic in the cryptocurrency world as it attempts to recover from the recent crypto winter. PoR is a process that allows users to verify that a company or individual has the assets they claim to have, but the specifics of how to conduct PoR and who should be responsible for it are still being debated.

Traditional auditing firms have struggled to provide adequate PoR for the cryptocurrency industry due to the constant trading that occurs in the sector. Doug Schwenk, CEO of Digital Asset Research (DAR), explained that audits are only conducted periodically, while cryptocurrency trades around the clock. “Ideally you would have a way to measure those liabilities and the assets in some kind of real time,” he said.

I'm sorry but no. This is not PoR. This is either ignorance or intentional misrepresentation.

The merkle tree is just hand wavey bullshit without an auditor to make sure you didn't include accounts with negative balances. The statement of assets is pointless without liabilities. https://t.co/b5KSr2XKLB
— Jesse Powell (@jespow) November 25, 2022

Centralized (CeFi) and decentralized (DeFi) platforms also present different challenges when it comes to PoR. Amit Chaurhary, head of DeFi research for Polygon, a scalable blockchain ecosystem, stated that DeFi platforms can offer “proof of reserve” due to their transparency. Polygon is currently developing the zero-knowledge Ethereum Virtual Machine (zkEVM), which uses Merkle trees to show both positive and negative balances and allows users to verify their accounts while maintaining privacy.

CeFi platforms, on the other hand, face more challenges when it comes to PoR. Matthew Niemerg, founder of the Aleph Zero blockchain, explained that since liabilities can be incurred off-chain, there is no way to show “proof-of-liabilities” and that a company can honor all customer deposits. Centralized cryptocurrency exchanges are taking various steps to provide PoR that meets the needs of their users, including using open-source Merkle tree protocols and real-time, third-party transaction tracking systems.

Ultimately, while technical advances have made PoR more effective, it will also require good regulation and a culture of compliance in order to be successful. As Schwenk stated, “In the world that we’re navigating right now, better than nothing is sometimes a good starting place.”