Proof of Reserves: How safe is your crypto?

Proof of Reserves (PoR) is a method by which exchanges publish a Merkle tree of customer balances and prove the funds held in wallets on the blockchain. It provides evidence about their assets, but it does not fully capture their liabilities. So on its own, it is not enough to judge whether an exchange can cover what it owes.

What is Proof of Reserves?

Proof of Reserves tries to make an exchange’s reserves verifiable, instead of leaving the customer with nothing but the company’s assurances. It combines a record of customer balances with proof of the funds held at blockchain addresses.

Think of a building manager who shows you the money in the maintenance fund. That is useful information, and clearly better than “just trust me.” But if you don’t also know the unpaid bills, you can’t tell whether the fund is enough. The same distinction lies behind the debate over PoR.

In our view, its value lies in the transparency it adds. The problem starts when this particular proof is presented as a complete answer about a company’s financial position.

How did it come to the fore after FTX?

The collapse of FTX was the backdrop against which Binance began publishing Proof of Reserves in November 2022. The question of what exchanges actually hold suddenly carried real weight: what is really behind the balances customers see?

In December 2022, Mazars suspended its work in this area. That development needs to be read carefully. It does not let us draw conclusions about the financial position of every exchange, nor attribute reasons to the decision that we don’t know.

Publishing reserves and assessing the overall financial picture remain different matters. That is the distinction to keep in mind, beyond names and announcements.

How does Proof of Reserves work?

Proof of Reserves links two sides of the information: the recorded customer balances and the funds proven on the blockchain. To understand it, we need to separate its main components.

Customer balances

Customer balances are the starting point of the record the exchange publishes. They reflect what appears in customers’ accounts and are a different piece of information from the funds held in wallets.

Seeing a balance on your screen does not, by itself, answer the question of what assets the platform holds to cover it. That is where PoR tries to add evidence.

The Merkle tree

The Merkle tree is the structure in which customer balances are organized for the PoR publication. The image of a tree helps: individual records are joined into branches that lead up to a common root.

You don’t need to learn how it is built technically to see its limitation. Organizing balances in such a structure does not automatically reveal every other financial obligation of the company.

Funds on the blockchain

Proving the funds held in wallets on the blockchain, known as on-chain proof, covers the asset side. The exchange does not just present book balances; it also proves holdings in wallets.

This is a real benefit of the mechanism. The discussion gains concrete evidence about reserves, without that meaning the review of all liabilities is complete.

What is the difference between reserves and liabilities?

Reserves show available assets, while liabilities concern what a business owes. To judge whether the former are enough, we need an adequate picture of the latter too.

This is the key limit of Proof of Reserves: it shows assets, but not liabilities in full. Even a useful proof of funds leaves open the question of whether the entire debt side is being presented.

Proof that reserves exist is not proof that we know everything that is owed.

A customer’s balance and the company’s total liabilities are not concepts we can treat as the same without further evidence. If we treat them as identical, we are asking PoR to prove more than it covers.

How do you read a Proof of Reserves in practice?

A practical assessment of a PoR starts with what is presented and continues with what remains unknown. If you open an exchange’s PoR publication, you can organize your reading in the following steps:

1. Separate out the customer record. Identify what is presented about balances and the Merkle tree.
2. Separate out the proof of funds. Look for what is proven about wallets on the blockchain, rather than settling for a general assurance.
3. Ask about liabilities. Check whether there is information beyond the recorded customer balances. Don’t assume the full picture is necessarily included in the PoR.
4. Limit your conclusion to the evidence. If funds are documented but not all liabilities, keep that difference in your assessment too.

This process doesn’t turn the reader into an auditor. But it helps make sure the gap between “reserves are presented” and “we have the full financial picture” doesn’t go unnoticed.

What are the advantages and the pitfalls?

The advantage of Proof of Reserves is the added transparency, while the main pitfall is placing too much trust in a partial picture. Both can be true at the same time.

Publishing balances through a Merkle tree and proving funds give the discussion concrete substance. We are not left solely with a corporate promise that “the money is there.” For us, that is a positive step.

On the other hand, the technical jargon can create more certainty than the evidence justifies. A Merkle tree does not fill in unknown liabilities on its own. Nor does a reference to an auditor relieve us of the need to understand exactly what was examined.

Mazars’ suspension of its work in December 2022 should be used neither as a blanket condemnation nor as an excuse for speculation. Every conclusion needs its own evidence.

What does it mean for Greek investors?

For a Greek exchange user, Proof of Reserves is information for assessing the platform, not a tax document or a guarantee that you will get your money back. The question remains which reserves are proven and how much we know about the liabilities.

We cannot infer from a PoR publication how transactions are reported to AADE (Greece’s Independent Authority for Public Revenue) or what tax treatment applies. Those are different matters that require separate documentation.

When reading announcements day to day, keep the distinction between transparency and a full financial assessment. A platform can publish useful data without it answering every question you have as a customer.

Our conclusion on Proof of Reserves

We consider Proof of Reserves a useful transparency tool, but with a clear limit on the liabilities it reveals. The right approach is neither to dismiss it as useless nor to treat it as a blank check of trust.

We look at what is proven, acknowledge what is missing and don’t fill the gaps with assumptions. That is where its real usefulness for the reader lies.