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Chainlink PoR feeds can be used for a wide range of tokenized real-world assets (RWAs), such as real estate properties that generate verifiable cash flows. Chainlink PoR can also be used to support the tokenization of other types of RWAs, such as commodities like gold and silver. Paxos and CACHE Gold are using Chainlink PoR to enable anyone to quickly verify on-chain that their tokenized gold products are fully backed by gold reserves held in off-chain custody. Proof of Reserves or PoR is a verifiable audit procedure that helps proof of work cryptocurrency increase the transparency of centralized cryptocurrency reserves and checks exchanges for fraud. PoR uses cryptographic evidence, verification of ownership of public wallet addresses, and repetitive third-party Proof of Reserves audits to validate centralized platform fund reserves.
Why Is Proof of Reserves (PoR) in Demand After FTX Collapse?
We introduce an array of proof-of-reserve metrics to easily monitor the balances of exchanges’ on-chain https://www.xcritical.com/ reserves held in self-reported addresses. The downside is that a CEX’s wallet balances don’t give much information regarding its management of customer funds. Again, they don’t show the exchange’s liabilities, a critical component of determining any firm’s solvency.
How Does a Proof of Reserves Crypto Audit Work?
- It also gives customers confidence that the company is solvent and liquid enough to continue doing business with them.
- This process continues until we reach the very top of the tree, where we have a single hash, known as the root of the Merkle Tree.
- By reviewing these reports, you can ensure that the exchange has undergone a thorough assessment by a reputable auditing firm, which adds credibility to the proof of reserves process.
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Proof of Reserves: Increasing Transparency for Centralized Platforms
‘Proof of Reserves’ is a specific audit for crypto institutions wherein a third party assesses the assets they own against their debt, also known as “liabilities”. The third party will count up every asset an institution can prove they own. These types of assets may include fiat assets, such as dollars or euros, or crypto assets, such as bitcoin and ETH. Following that, the auditor will collect the data on the same institution’s debt and tally up the total. The benefits of Proof of Reserves crypto exchanges offer to users would focus on the accessibility of hands-on transaction records. Proof of Reserve applications offers a transparent account of an institution’s finances.
What’s the difference between an audit and an attestation?
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While a Proof of Reserves audit helps centralized platforms become more transparent, it doesn’t make them any more secure. To explain, when using a centralized exchange, you don’t actually control your private keys. Unfortunately, this means you don’t really own the assets stored at the corresponding address.
As for adopting a PoR strategy, I suggest following the rubric laid out above. The current state of the art is the Merkle method, but ZK-liability solutions are emerging and should be considered. However, cryptocurrency users have a revealed preference for custodial ownership, at least for a portion of their coins. By encouraging custodial exchanges to adopt PoR, I am hoping that user assurances at custodial exchanges can be bettered. In total, Binance holds more than $69 billion in its hot and cold wallets, and it provided the public wallet addresses for six of the 600 assets it supports. As of writing, most of these exchanges have provided either a basic audit of their holdings or a full breakdown of their digital wallets.
Decentralized finance (DeFi) provides an alternative by offering highly transparent, trust-minimized financial products that are powered by deterministic smart contracts and cryptographic truth. With the growth of DeFi comes an increasing demand for new collateral types that extend beyond native on-chain assets, including cross-chain tokens, fiat-backed stablecoins, tokenized real-world assets, and more. Kraken implements an “audits” button on user accounts utilizing the Merkle tree functionality.
This proof can take different forms depending on the nature of the institution and the type of assets involved. Only exchanges that have more assets in reserve than they have debt (or liabilities) can achieve Proof of Solvency. If all of an exchange’s users try to withdraw their funds and it can process every single request simultaneously, an exchange will pass the audit. If an exchange fails this test, it’s running on fractional reserves, meaning it’s using customer funds. The global financial system commonly operates in an undercollateralized and highly opaque manner, creating systemic risks that can result in boom and bust cycles and market-wide failures.
Understanding, and keeping up with these dynamics however is essential, in order to provide the most accurate exchange metrics possible. Our existing suite of Exchange Balance metrics are the result of these sophisticated data acquisition systems, which use a combination of publicly available information, clustering algorithms, and exchange-specific heuristics. Ensure stablecoins, CBDCs, and wrapped cross-chain assets are properly backed. Smart contract developers can integrate Chainlink Proof of Reserve as a circuit breaker to help ensure unexpected fractional reserve activity from issuers does not result in cascading user losses if unbacked tokens are minted. Chainlink Proof of Reserve enables the reliable and timely monitoring of reserve assets using #ProofNotPromises.
In the context of this article we only refer to the on-chain reserves as communicated by the exchanges. Liabilities are not reported, as these include a mix of on-chain and off-chain data known only to the exchange. While such audits prevent record tampering, they aren’t without their downsides. These reports can only be valid at the audit time and may be overtaken by events in a highly dynamic sector such as crypto. Chainlink Proof of Reserve utilizes the largest decentralized collection of security-reviewed and Sybil-resistant node operators in the industry to acquire and verify reserve data.
Regular audits will minimize risk and establish global crypto standards for security. Many things could go wrong in an audit — the third-party auditor might not be the best, an exchange might have undisclosed liabilities, or they could fail to keep customer funds safe from hacks. As explained by Vitalik in his blog, PoR is more of a quick fix than a long-term solution. Swingby is using Chainlink PoR to help secure its cross-chain bridge and protect users by preventing wrapped tokens from being minted or swapped if the reserves backing them become undercollateralized.
However, conducting these audits frequently can be expensive and time-consuming. While proof of reserves is a valuable concept in ensuring the safety of your funds, it’s important to acknowledge that it does come with its fair share of challenges and limitations. By prioritizing the verification of reserves, the system offers users the assurance that their funds are secure, fostering a more robust and reliable financial ecosystem. By verifying and validating these reserves, users can have peace of mind, knowing that their assets are protected and won’t disappear overnight due to mismanagement or bankruptcy.