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.

Proof of reserves is a verification method used by crypto exchanges to demonstrate that they hold sufficient assets to cover all customer balances. It’s meant to build trust by proving the platform isn’t operating on fractional reserves. Exchanges usually publish wallet addresses and work with independent auditors who check on-chain funds and compare them with anonymised customer liabilities. A common approach uses Merkle trees, which allow users to confirm that their balance is included without revealing personal data. If assets match or exceed liabilities, the exchange is considered fully backed. While useful, proof of reserves is not perfect because it doesn’t always show hidden debts or off-chain obligations. Still, it gives customers a clearer picture of an exchange’s financial health.