What is proof of reserves?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 6 min
In short
Proof of reserves is how an exchange shows it holds assets matching what customers have deposited. Most schemes use a Merkle tree so each customer can verify their own balance was included. But without the liability side, proving you hold assets proves nothing about solvency.
Key points
- A verifiable way to show holdings match customer deposits
- A Merkle tree lets each user check their balance was counted
- Without liabilities it says nothing about solvency
- It is a snapshot of one moment, nothing more
Definition
An exercise in showing, verifiably, that a firm's holdings are not less than what it owes its customers. The term is sometimes used loosely for the asset side alone.
The core mechanism is a Merkle tree. Customer balances form the leaves, hashes are combined upward, and the root is published. Each customer receives the path needed to confirm their own balance was included, without learning anyone else's.
On the asset side, the firm discloses the addresses it controls so that anyone can read the balances from an explorer. To show it genuinely controls them, it typically signs a specified message or moves a nominated amount.
And here is the trap. All of that proves how much is held, not how much is owed. If the liability side is incomplete, the firm can leave some customer balances out of the tree, or borrow assets briefly to dress up the snapshot. The exercise only means something when liabilities are included and an independent party has checked the procedure.
What you can assess as a customer is how often it is published, which assets and which customers are in scope, how liabilities are handled, and whether you can actually run the verification yourself. A badge saying it was done is not the same as a report worth reading.
Watch out for
- · An asset-only disclosure is not evidence of solvency — check how liabilities are treated
- · It is a snapshot and guarantees nothing about the days after it
- · Borrowing assets temporarily to flatter the snapshot is possible in principle