What is Proof-of-Reserve and why your exchange needs one!

You’ve probably heard the term “proof-of-reserve” since the spectacular fall of the FTX platform. This supports the fact that users feel increasingly insecure when depositing their funds on centralized platforms. The bankruptcy of the Celsius lending platform has already left its mark with the freezing of customer funds.

Since then, users have been demanding more transparency. Thus, many exchange platforms such as Binance have decided to publish their “proof-of-reserve” to reassure their customers. The term can be translated into French as “proof of reserve”.

Traditional banks are harshly regulated and are obliged to declare the amount of their reserves, that is to say the amount of their assets. This is then stated in their annual reports and helps ensure that client funds are not used. However, let us remember that despite the various insurance measures, banks can still go bankrupt...Must we remind you of the masterful fall of Lehman Brotherss in 2008?

When it comes to centralized exchange platforms, regulations and security measures are almost non-existent. It then appears that "proof of reserve" could be a satisfactory measure to take.

Let's see what it is precisely but if you have any doubts, do not hesitate to withdraw your bitcoins from exchange platforms time to do your little investigation.

What is “Proof of Reserve”?

A proof of reserve is an independent audit that is carried out by a third party company. This allows you to know if a custodian (a crypto exchange platform for example) really owns the assets it claims to own.

Most crypto companies (crypto platforms generally CeFi) store their data on their own private databases. So, as we cannot access the funds they own and we also cannot access their private managements.

Obviously, companies will then claim that the funds are safe. Who can verify? As you might expect, an average customer, lacking concrete proof, will have to be content with “trusting” the platform.

And history has taught us that companies are not all honest and that very often they "play" with their customers' deposits.

This is precisely where the proof of reserve takes on its full meaning. The customer no longer needs to trust, he has concrete proof.

Once again, we remind you of a supreme adage: "Don't trust, verify". Finally, users of these platforms can apply this maxim.

Why should you choose an exchange that has proof of reserve?

If you want to sleep soundly, you will need to choose an exchange platform that is secure. By choosing a platform that has proof of reserve, you will be assured that exchanges do not use your funds in dangerous trading operations. This was particularly the case with FTX…

Likewise, this is valid for other types of platforms such as lending platforms (Ah, RIP Celsius!). For example, proof of reserve guarantees that the company does not lend more money than there is in collateral. Thus, lenders can be repaid in full.

What security does proof of reserve give us?

To summarize, here is what a proof of reserve tells you:

–The company is not insolvent and owns the assets

–User funds are safe and are not used in trading. They are available at any time to make withdrawals.

How does Merkle Tree proof of reserve work?

To explain how proof of reserve works technically, we need to talk to you about the “Merkle tree.” It’s a concept that underlies how the Bitcoin blockchain (and blockchain technology, in general) works.

A Merkle tree provides a method of crypto-secure verification of assets in reserve. At the slightest change, the database is updated. Thus, due to its inviolable nature, the data cannot be manipulated or modified. So, if a platform wants to falsify the data and indicate that it has more reserves for example, the entire hash will be modified.

Here again, the Merkle Tree proof of reserve is carried out by an independent auditing company. Here is how the procedure works:

1. The auditing company notes all user balances held by a platform and organizes it structurally into a Merkle tree.
2. A computer algorithm will then configure all of the data and create a new computer entity of 64 characters.
3. The platform's digital signatures then show the total balances and are represented in the Merkle tree. We can therefore see that the funds deposited by users are held in the platform's reserve. This is then proof that there are assets in reserve.
4. With a unique identifier, the audit can verify the data by comparing with the data with the Merkle root. In fact, the slightest change in the asset balance (even a small one) would result in a complete change that would go up the entireMerkle tree and would thereby change its value.

As you can see, by using the Merkle tree functionality, we then have a very precise way to ensure that all transactions are validated in full.

—->Read the article: What is the Merkle Tree and how does it relate to Bitcoin?

How to ensure using an exchange platform is reliable and secure?

Here are 3 things you should consider before choosing your exchange platform:

✅ 1) Check that the exchange platform has a “proof-of-reserve”.

For the moment, we will have to make do with the platforms that are currently in the process of achieving it. However, you need to choose a platform that is committed to doing so.

✅ 2) You must also ensure that your platform uses enhanced security systems such as depositing assets in cold wallets. Platforms like Youhodler have been doing it from the beginning, for example. This avoids and reduces the risk of hacking.

✅ 3) The best of the best: Your exchange platform focuses on the trading experience with a careful listing of tokens. These are also platforms that have not created tokens to pay trading fees. There are very few platforms of this type but we can cite OkCoin which is a healthy platform in this sense. Likewise, the fees generated are used in part to finance the developers of the bitcoin network. This is a particularly interesting platform for bitcoiners.

Which exchange platforms have proof of reserve?

Currently, only Creak actually published a proof of reserve. It is then a highly recommended exchange platform. It is currently the only one to have carried out a proof of reserve, even before the fall of FTX…

Other platforms have nevertheless indicated that they will publish their proof of reserve including: Binance, Kucoin,CoinList, Okex, Phemex, ZenGo etc. Be sure to follow their posts and check social media for communications on this subject.

Note: We are preparing an update of the most secure exchange platforms. We will give you the list of platforms that have a proof of reserve.

Final word on proof of reserve

The Merkle Tree proof of reserve gives us quick assurance that the company is transparent. What is certain is that proof of reserve will become one (or THE) ultimate criterion to take into account before depositing funds in a platform.

Likewise, we are not safe from yet another black swan…We cannot remind you of the other adage to engrave in your memory "Not Yours keys, not yours coins". Do not hesitate to obtain un hardware wallet for even more security.

For example, you can opt for a Ledger key with the following 10% promotion code: NYKNYC (Yes, this is the acronym of the adage cited above):

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Note: No financial advice is given in this or any other article on zonebitcoin. This is information of which you are the sole judge and master. Be responsible with your investments and only invest as much as you are willing to lose.

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