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Proof of Reserves – What It Means and How Does It Work?

DeFi provides transparent and secure financial solutions through deterministic smart contracts and cryptographic security. PoR is an independent audit that verifies a corporation’s adequate reserves to support customer balances, reassuring consumers about liquidity and solvency.

Understanding Of PoR?

Proof of reserves (PoR) is an auditing practice for cryptocurrency companies that promotes transparency. Third-party auditors use cryptographic signatures to objectively evaluate the company’s reserves  and determine if they cover potential customer withdrawals. This process ensures that customers can confidently withdraw their funds anytime and helps prevent a liquidity crisis in case of sudden withdrawals. PoR utilizes blockchain technology to protect user data and ensures the security of the auditing process.

Function Of PoR

To understand proof of reserves, we must first understand general auditing procedures. The audit should determine if an exchange is solvent or insolvent. If its assets exceed its liabilities, it’s solvent. But the binary result may not be enough in fractional reserves. In these cases, a portion of the exchange’s deposits is held in reserve while the rest is lent out.

Three Main Stages Of Audit

  • Proof of Liabilities: The cryptocurrency owed by exchange customers are the exchange’s responsibility. Liabilities are calculated by adding account balances and compared to reserves to determine solvency. Proof of liabilities involves hash computation and Merkle tree roots. 
  • Proof of reserves: Reserves refer to the cryptocurrency assets stored by the exchange on the blockchain. The exchange verifies ownership of Bitcoin addresses by providing the public key and signing with the private key, including a nonce for security purposes. By adding up balances of crypto addresses that the exchange controls, the total assets are determined.
  • Proof of solvency: A cryptocurrency exchange’s proof of solvency consists of two parts: audit outputs and an attestation to verify that the audit was run in a reliable environment. The audit result is either true or false, depending on whether reserves exceed obligations. The attestation serves as a signature for the program hashes and platform measurements. By using the Merkle tree’s root, consumers can verify that their account balances were included in the computation.

Final Takeaways

DeFi provides transparency and secures financial solutions through smart contracts. Proof of Reserves (PoR) is an independent auditing practice for cryptocurrency firms that objectively assesses their reserve assets. Third-party auditors examine cryptographic signatures to ensure assets are sufficient to cover customer withdrawals. PoR uses blockchain tech for safe auditing without disclosing user data. The audit determines if the exchange is solvent or insolvent based on its assets and liabilities. Customers can withdraw their cash anytime with confidence in the crypto firm’s liquidity.

IEMA IEMLabs
IEMA IEMLabshttps://iemlabs.com
IEMLabs is an ISO 27001:2013 and ISO 9001:2015 certified company, we are also a proud member of EC Council, NASSCOM, Data Security Council of India (DSCI), Indian Chamber of Commerce (ICC), U.S. Chamber of Commerce, and Confederation of Indian Industry (CII). The company was established in 2016 with a vision in mind to provide Cyber Security to the digital world and make them Hack Proof. The question is why are we suddenly talking about Cyber Security and all this stuff? With the development of technology, more and more companies are shifting their business to Digital World which is resulting in the increase in Cyber Crimes.
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