Following the FTX crash, many crypto exchanges introduced proof of reserve in order to gain more trust from their users. In this article, I will show you what to look out for.

What is an exchange proof of reserve?

According to Cointelegraph, “Proof of reserves (PoR) is an independent audit conducted by a third party that seeks to ensure that a custodian holds the assets it claims to own on behalf of its clients.”

Basically, an independent auditor needs to take a snapshot of all the balances held in the customers’ accounts and aggregate the balances, then compare it with the total balances of the crypto exchange’s on-chain addresses, to see if the exchange holds at least the same amount as the total amount from the customers’ account. The auditor also needs to check the exchange has ownership of all the addresses they provided.

Usually, crypto exchanges store the hash value of each of their users’ account balances in the leaf node of a Merkle tree.

How can you check an exchange’s reserve information?

If you want to find out whether an exchange has issued information on PoR, the easiest way is to just google “[exchange name] proof of reserve”.

Websites such as Coingecko and Coinmarketcap also list various information about exchange including data about their reserves. For example, for each crypto exchange Coingecko features an ‘exchange reserves’ section. The ‘Read more here’ link will take you directly to the exchange’s proof of reserve webpage.

Take note that crypto exchanges reveal their reserves in different ways. Not all exchanges use a third-party auditor to complete the PoR procedure.

For example, Bitfinex lists out their hot wallet addresses. Users can use the respective explorers to check the balances of these wallets.

Publicly traded exchange Coinbase explained that they do neither of the above because their financials must be reviewed by external auditors regularly and filed with the SEC.

How to assess a crypto exchanges proof of reserve information

When looking at an exchange’s proof-of-reserve, you should check the following things:

1. Does the exchange use a qualified third party to do the audit?

After the crash of numerous crypto exchanges, we should not easily believe what an exchange is telling the public. That’s why qualified third-party auditors for the PoR are essential. For example, Gate.io partnered with Armanino for PoR. There is a detailed report on Gate.io’s website you can download.

I also found that Armanino lists their clients on their website and that you can also download the reports from there.

On the contrary, OKX’s reserve ratio seems to be self-reported. There is not much information on their website regarding an independent audit, only the amount of reserves.

2. Can users verify the balances by themselves?

On Gate.io and OKX, there are detailed tutorials to teach users how to verify if their account is included in the Merkle tree leaf node. You should verify with the exchange you are using if they also offer this service.

3. Is there a detailed proof-of-reserves report for users to read?

If a qualified third-party auditor is hired, they will issue reports detailing the procedure and findings.

This is very important because you can find a lot of useful information inside. For example:

4. Does the report show the exchange’s liabilities?

A very important concept you need to understand is that the coins and tokens held by crypto exchanges on behalf of their clients are not the exchange’s assets, but liabilities. Normally, a PoR report should show the liabilities of the exchange.

Final Words

Being open about PoR is definitely an important step taken by crypto exchanges to become more transparent. However, just because a centralized exchange has reliable proof of reserve, it does not mean that it is 100% safe. PoR only proves there are enough balances at a certain point in time. It does not show how many total liabilities an exchange has or other issues that might exist.

That’s why you should only use exchanges for trading but not for storing your crypto assets. The only safe way is to store your assets in a hardware wallet and hold the key by yourself. Always remember not your keys, not your coins.

Disclaimer: This article is for educational and informational purposes only. It represents the author’s personal opinion and should NOT be treated as investment or financial advice.