Proof of reserves (PoR) is a method used by cryptocurrency exchanges to demonstrate that they hold enough assets to cover customer deposits. It is designed to increase transparency and build trust, especially in an industry where concerns about solvency and misuse of funds are common.

In practice, proof of reserves involves a third-party audit or cryptographic verification. The exchange provides evidence that the total assets in its wallets are equal to or greater than the sum of all customer balances. Typically, the process uses a Merkle tree, a cryptographic structure that allows auditors to verify individual user balances without exposing private information. Each customer’s account is represented as a leaf in the tree, and the aggregated data can be matched against the exchange’s on-chain wallet balances.

The goal is to give customers confidence that the platform is not running fractional reserves, meaning it is not lending or misusing deposited funds without adequate backing. However, while PoR is a valuable step toward accountability, it has limitations. It usually confirms only assets, not liabilities, since exchanges may have debts or obligations that are not revealed in the audit.

Overall, proof of reserves is an important mechanism to improve transparency, encourage responsible exchange practices, and reduce the risk of hidden insolvency in the crypto sector.