The Power of Proof of Reserves: Exchanges, Stablecoins, & ETFs
In the evolving landscape of cryptocurrency and digital assets, trust remains a cornerstone of adoption and growth. The concept of Proof of Reserves (PoR), born in the aftermath of the catastrophic Mt. Gox collapse, has become a crucial mechanism to ensure transparency and accountability across various facets of the crypto ecosystem.
From exchanges and stablecoins to tokenized assets and ETFs, Proof of Reserves is shaping the future of crypto by addressing a fundamental question: Do issuers hold the assets they claim to on behalf of their customers? This blog explores the origins, applications, and future of Proof of Reserves, detailing its importance for crypto companies and the public.
The Origins of Proof of Reserves
The story of Proof of Reserves begins in the dark days following the Mt. Gox debacle in 2014. At its height, Mt. Gox handled over 70% of Bitcoin’s trading volume, but its collapse due to a massive loss of funds—750,000 Bitcoins—left the industry reeling. Prices plunged, and confidence hit rock bottom.
Amid this turmoil, crypto developers like Greg Maxwell and Peter Todd conceptualized PoR as a way to rebuild trust. Maxwell had articulated a two-part solution:
Proof of Assets: Demonstrating control of private keys controlling customer funds on-chain via digital signatures and signed messages.
Proof of Liabilities: Validating that the liabilities owed to customers match or less than the assets held as tracked on the exchange’s database.
While initially designed for exchanges, this concept has since expanded to stablecoins, tokenized real-world assets (RWAs), and beyond. In all cases, the same challenge of confirming the issuer holds assets in excess of customer liabilities is the paramount importance.
When is Proof of Reserves Applicable?
Exchanges: Centralized exchanges often operate as custodians, holding user deposits and facilitating trades. This creates a liability or “promise” to “pay back” customers upon request for withdrawal.
How PoR Works:
Assets: Exchanges aggregate user deposits into pooled wallets (hot, warm, and cold storage). Proving assets involves gathering a list of all custodial addresses and proving ownership of each, either via digital signatures, “send-to-self” transactions, or another method that demonstrates control of the private keys holding customer assets. Then, the asset balances are queried for those addresses as of a specific point in time, with the total unit balance equating to “Total Customer Assets.”
Liabilities: Then, a report of all customer balances from the exchange’s database should be extracted. The summation of these “IOUs” owed to customers is the “Total Customer Liabilities” balance. The equation is simple: Customer Assets should be greater than Customers Liabilities.
Challenges:
Large Volume: Exchanges typically have hundreds of thousands or even millions of addresses.
Customer Liability Database: The customer database tracking liablities owed to customers can be manipulated. This is where independent parties can be valuable in the Proof of Reserves process.
Stablecoins: Stablecoins like USDT and USDC represent another major application of PoR. Their value is derived from being backed 1:1 by reserves such as fiat currencies or short-term treasuries.
How PoR Works:
Assets: For each stablecoin issued, an equivalent dollar value must be held in reserve. The issuer demonstrates cash, cash equivalents, or other instruments held in accounts with financial institutions. The balances observed at each financial institution as of a specific point in time equate to “Total Customer Assets.”
Liability: The liabilities in this instance are tokens issued on a blockchain, redeemable for the underlying dollar. These balances are public and visible on blockchains! The summation of these tokens issued on the in-scope blockchains is the “Total Customer Liabilities” balance.
Challenges:
Historical Blockchain Data: Obtaining historical blockchain data from chains like Solana can be challenging.
Valuation of Assets: Often times, issuers earn yield on underlying assets. The aaluation of these assets (and disclosing the methodology) is key to ensuring the public is appropriately informed.
Exchange-Traded Funds: Crypto-based exchange-traded funds (ETFs) like Bitcoin ETFs are a bridge between traditional and crypto finance.
How PoR Works:
Assets: ETF’s typically hold “in-kind” assets to back the Exchange-Traded Products. Therefore, for a bitcoin ETF, spot bitcoin is held in custody.
Liability: The liabilities in this instance are notes or shares issued and tradeable on stock or security exchanges. The summation of the NAV of these notes issued is the “Total Customer Liabilities” balance.
Challenges:
NAV Calculations: NAV calculations can be complicated to derive a true liability figure.
Rebalancing: “Index” products may be rebalanced frequently, causing challenges in ensuring all changes are appropriately captured period over period.
Why Proof of Reserves Matters
Proof of Reserves is more than a technical tool—it’s a commitment to transparency and user trust. As crypto moves toward mainstream adoption, PoR will be integral in mitigating risks and aligning the industry with user expectations.
For crypto companies, adopting PoR is no longer optional—it’s a competitive edge in building trust.
Learn More
For a comprehensive dive into Proof of Reserves, explore the Digital Chamber’s Proof of Reserves Guide and subscribe to The Network Firm YouTube Channel.
Ready to lead in transparency? Contact The Network Firm for expert guidance on establishing a robust Proof of Reserves framework.
Author Bio:
Jeremy is a CPA with more than 10 years of experience performing compliance audits, internal audits and financial statement audits for digital asset clients. Jeremy co-led a high growth team at a large CPA firm for the past 4 years and is recognized as a leading expert on stablecoins and stablecoin assurance. Jeremy has developed proprietary, technical audit procedures for testing ownership and control of digital assets since 2016.
Jeremy and partners created and launched the world’s first application of real-time attest technology in 2018 and have since pioneered Proof of Reserves methodologies and reporting standards.
Jeremy is a Certified Public Accountant (CPA) and Certified Management Accountant (CMA), with membership at the AICPA and the Florida Institute of Certified Public Accountants (FICPA). He is Certified Blockchain Professional (CBP) and member of the Cryptocurrency Certification Consortium (C4). Connect with The Network Firm on LinkedIn or X/Twitter for more expert advice.