Today, various exchanges are working and providing services to their customers, and their number is increasing day by day. These exchanges have a duty to comply with standards and prove themselves in some way. It is necessary to record some information and accounts in the world of blockchain, and exchanges must show their good faith in this matter in order to prevent security problems from occurring. After the disaster of the FTX crash, this issue became more important and to a large extent people lost their trust in exchanges. In order to create financial transparency and gain trust, exchanges use Proof of Reserve.
In general, in the financial markets, reserves are assets that are kept by a company and the exchange acts as a trustee for them. These assets can be collected for different purposes, including depositing, holding and conducting transactions of companies that have financial activities. These information and assets must be registered and protocols implemented on them in order to create security. This transparency creates trust and prevents crises. Since there are various institutions in the field of providing financial services to people, it is important to choose the most reliable one from among a large number of them and show importance to its safety.
Since the industry and the world of digital currencies are developing and expanding day by day, building trust among people and institutions is very important. The reason is that this industry cannot continue to grow without trust and acceptance. Exchanges and institutions like this, by implementing the proof of deposit protocol, ensure that their customers’ assets are really with them and their place is safe.
It is interesting to know that earlier, one of the most famous digital currency exchanges collapsed due to non-compliance with the mentioned standards and eventually went bankrupt. The downfall of the FTX exchange started when this entity made unrealistic promises and information to its users and it turned out that it did not have enough digital currency. Following the unspecified and astronomical debt payment of the companies affiliated with Bankman Fried, the founder of this entity, the bankruptcy of FTX exchange occurred. The fall of the FTX exchange and its bankruptcy is an example of the importance of proof of reserve, and after this incident, people’s attention was drawn to this issue more than before. That being said, the FTX exchange is a major case that resulted in the theft of hackers and the loss of a large amount of assets.
As mentioned, proof of storage is a way for an entity to verify the audited information and its accuracy; But how exactly does this happen and how is Proof of Reserve done? Merkel tree is considered a data structure that is very important in cryptography and is a tool with the help of which data is verified. This process is carried out with specific instructions, and if a change occurs in the data, experts will quickly recognize it. Proof of reserve is usually done by a third party.
In fact, the exchange provides its financial information to an authentic and reliable auditing company. The company checks the accuracy of the information and confirms that the exchange has kept the claimed property. This process makes users trust to continue using the exchange and financial institutions in general and not to leave the chain. It goes without saying that the accuracy of the qualification of the auditor company is also important and it is one of the other parameters that should be taken into consideration.
Different exchanges with different names and logos are providing services to their users and each one has advantages and disadvantages compared to the other. According to international laws, there are protocols that exchanges are required to follow and must follow in order to keep their customers. One of the protocols is proof of storage, which plays a large role in proving the integrity of the exchange, but this element is not the only thing that matters.
The thing that is usually recommended to investors is to be careful about the property that they provide to the exchange and to check the institution in advance and try to get to know it. It is better for the investor to use exchanges that have a name and logo and have proven themselves to the public. Also, there are a number of exchanges that have shared documents related to their proof of reserve. Binance, OKX, Kocoin, Poloniex and Crypto.com are some of these entities that try to show their good faith and integrity to the public. With all this, we advise investors to keep most of their assets in their wallets.
Above, we mentioned the importance of proof of reserve protocol and the reason for compliance by exchanges. Proof of Reserve reduces security risks and protects users’ assets. Also, with the transparency that the exchange creates through this process, people and companies gain more trust and the world of cryptocurrencies can continue to progress. Thanks to this standard, exchanges are obliged to protect their clients’ assets. In fact, for example, an exchange cannot abuse these assets or use them to invest and increase profits. In other words, with Proof of Reserve, anyone can verify the validity of
and confirm the assets with the desired exchange. Finally, this issue makes institutions feel more responsible towards the property of customers and not make mistakes.
Consumer protection is an issue that has always been important and is even something that exchanges compete on. By respecting users’ rights and trusting their assets, consumers can use financial services with ease. Also, it becomes easier to prove the accuracy of the information provided by the exchange and contributes to greater transparency. Proof of asset reserve ensures that no one can borrow more than the collateral they have and this prevents potential abuses. Strengthening the ability to assess risk, removing bad actors from the scene and dealing with systematic risks are other positive features of proof of reserve. But what are the disadvantages of this standard?
Proof of deposit, like many other processes, has two sides to the coin and can be troublesome. It may be strange to you that Proof of Reserve has flaws and is not completely flawless. As you know, it is very important to keep people’s information safe in the storage proof process, and everyone is careful about this issue. However, Proof of Reserve can sometimes expose people’s personal information and inventory. It is true that the exchange has a duty to preserve the information it holds as much as possible, but there is a possibility that the user’s balance will be revealed at the time of providing the proof of storage. This is different from the nature of the world of digital currencies and reduces the ambiguity of addresses related to wallets. Hackers can also use the information in Proof of Reserve.