Chainlink Proof of Reserve provides both the growing DeFi ecosystem and the traditional financial system with a way to boost the transparency of their operations through definitive on-chain proof of any asset’s true collateralization. As the smart contract ecosystem grows, it is critical to proof of reserve ensure market failures caused by opaque operational processes and toxic collateral are consigned to history. With Chainlink Proof of Reserve, the DeFi ecosystem is well-positioned to scale and help secure the next generation of trust-minimized financial products.
Chainlink PoR can also be used to support the tokenization of other types of RWAs, such as commodities like gold and silver. Paxos and CACHE Gold are using Chainlink PoR to enable anyone to quickly verify on-chain that their tokenized gold products are fully backed by gold reserves held in off-chain custody. The global financial system commonly operates in an undercollateralized and highly opaque manner, creating systemic risks that can result https://www.xcritical.com/ in boom and bust cycles and market-wide failures.
As traditional banks and asset managers expand their services to include digital assets, proof-of-reserves will feature more prominently as an industry gold standard for credibility and trust. When the penultimate two nodes are summed, it creates a final node in the tree called the Merkle root. The Merkle root represents the sums of all users and balances, used to verify a large data set with just one piece of information. An auditor takes the summed balance in the Merkle root and compares it against the exchange’s proven holdings.
Decentralized finance (DeFi) provides an alternative by offering highly transparent, trust-minimized financial products that are powered by deterministic smart contracts and cryptographic truth. With the growth of DeFi comes an increasing demand for new collateral types that extend beyond native on-chain assets, including cross-chain tokens, fiat-backed stablecoins, tokenized real-world assets, and more. Although proof of reserves offers assurance that a crypto company has the assets in place to cover its liabilities, it is only a single snapshot in time, not a live accounting of balances over time. It also only shows the on-chain assets of the custodian; it does not track where those assets come from (i.e., whether the assets were borrowed for the purposes of the audit). Coinbase addresses these concerns by reporting its assets to regulators in compliance with being a publicly traded company in the United States.
Asset tokenization projects such as TUSD, PoundToken, and Cache Gold have integrated PoR Secure Mint to employ this standard for tokenized asset transparency, security, and verifiability. Proof-of-Reserves, or short PoR is a publicly shared and verified background check or an independent audit conducted on crypto exchanges by a third-party auditor. For the PoR to work as a true PoS, it's also crucial for users to be able to check the liabilities themselves against the reserves. While useful, more is needed to re-establish trust in a world where trusted third parties can, all too often, be security holes. Proof of Reserves (PoR) is a method of using cryptographic verification to demonstrate possession of digital assets.
Chainlink PoR feeds can be used to provide increased transparency for liquid staking derivative tokens, enabling anyone to verify whether liquid staking tokens are fully backed by staked native tokens. Swingby is using Chainlink PoR to help secure its cross-chain bridge and protect users by preventing wrapped tokens from being minted or swapped if the reserves backing them become undercollateralized. Secure Mint is being integrated by stablecoins, such as Poundtoken, and tokenized assets, such as Cache Gold, in their minting smart contract to help ensure reserves are sufficient before minting new tokens. Chainlink PoR Secure Mint enhances stablecoin and tokenized asset security by providing cryptographic guarantees that new tokens minted are backed by reserves, helping to prevent infinite mint attacks.
Thus, PoR should always include wallet addresses to enable the tracking of fund movements. The collapse of TerraUSD and FTX underscores the need for a reliable way to prove crypto platforms properly manage customer deposits. PoR is thought to reduce audit tampering by documenting all on-chain activities, including monitoring wallets to track asset movements.
Some exchanges and crypto lending platforms, including Kraken, Nexo, BitMEX, and Gate.io, moved to launch their proof of reserves before the implosion of FTX. TUSD uses Chainlink PoR in an additional way—to add even more enhanced security and transparency to the stablecoin minting process. Chainlink Proof of Reserve Secure Mint enables stablecoin issuers to programmatically require reserves to be greater than or equal to the supply being minted. By providing cryptographic guarantees that new tokens minted are backed by reserves, PoR Secure Mint takes tokenized asset and stablecoin security to the next level, helping to prevent infinite mint attacks.
Following this model, Proof of Reserve reference feeds can be deployed to track the collateralization and secure the minting of any stablecoin backed by off-chain fiat reserves. Through this data, the economic activity of stablecoins can accelerate within DeFi not only from retail users but also from traditional institutions that are seeking to securely generate yield in the decentralized finance ecosystem. Well, public transparency blocks a crypto exchange from making any secretive financial transactions, such as for example, loaning out more money than the collateral it holds and risking insolvency. Although we use the term "Proof of Reserves" for convenience, the reserve ratios we mentioned above offer a Proof of Solvency.
The goal of providing proof of reserves is to offer financial transparency about a crypto company’s balance sheet, especially in regard to customers’ funds. A third-party audit gives consumers confidence that the crypto company they are using has sufficient liquidity to handle day-to-day operations, and more importantly, customer withdrawals. Proof of reserves is completed by a third-party auditor that creates a snapshot of all of the company’s balances to show transparent “proof” that the crypto company has enough assets to cover its liabilities at any given time. This gives customers confidence that the crypto company is not at risk of a liquidity crisis, and that customers can withdraw their funds at any time. It is a way for a CEX (centralized exchange e.g. Binance, Crypto.com, Coinbase) to provide transparency by revealing in public that they hold in their reserves enough assets to match user deposits.
While these efforts are a leap forward in transparency, many don’t provide any window into liabilities, limiting their usefulness. BitMEX is a notable exception with a Bitcoin proof-of-reserves and proof-of-liabilities system. However, the system remains a work in progress, and the process of computing these proofs is too complex for most users. These companies appear to have a habit of hiding their reserves or outright lying about them. An exchange may have used your money to prop up its failing trading firm, as happened with FTX. They may have accidentally wired hundreds of millions of dollars worth of customer funds to another exchange, as befell Crypto.com, or lost it all in a hack, as happened with Mt. Gox.
As these audits are commonly done by a centralized third party, they can be lengthy, time-consuming, and require manual processes. Additionally, we delve into the cleanliness and status of a platform's reserves and how the PoR process works to provide transparency. Finally, we examine measures that cryptocurrency platforms can take to increase transparency and improve customer safety. As cryptocurrency continues to gain popularity, protecting the safety and security of customer funds is crucial. One way to achieve this is through Proof of Reserves (PoR) audits, which provide transparency and verification of a platform's solvency. Proof of Reserves allows centralized exchanges to provide users and fellow institutions visibility into the state of digital assets on hand, helping assure stability within digital asset markets.
Within the blockchain space, proof of reserves is commonly known as an independent verification that enables centralized exchanges to publicly report the value of their reserves and prove their solvency. Because centralized third parties typically conduct this reporting, they can be lengthy, opaque, and time-consuming manual processes.Chainlink Proof of Reserve (PoR) builds upon this concept to provide a customized solution for Web3. It enables seamless, decentralized, and autonomous proof of reserves reporting by verifying collateral amounts and posting that data onchain. With Chainlink PoR, users have more transparency, updates in real-time, and stronger guarantees around the proof of reserves’ accuracy. Chainlink Proof of Reserve provides smart contracts with the data needed to calculate the true collateralization of any on-chain asset backed by off-chain or cross-chain reserves. Chainlink PoR feeds can be used for a wide range of tokenized real-world assets (RWAs), such as real estate properties that generate verifiable cash flows.
Ideally, users can be assured that exchanges safely hold their assets through verification of PoR. A crypto exchange could lie outright, and a third-party attestor could still uphold the lie. If the attester is corrupt or incompetent, perhaps by overlooking missing wallets or failing to understand how an exchange had structured customer holdings, the whole purpose of proof of reserve would be undermined. There are no formally accepted rules or procedures that define a Proof of Reserves audit. You should not construe any such information or other material as legal, tax, investment, financial, or other advice.
All of these checks and balances ensure that a crypto company has the reserve assets that it needs to serve all customers, and that liquidity is maintained no matter the market conditions. Using the summation Merkle tree approach instead of a simple Merkle tree makes sure the user balance for each user account is part of the hash generation input. It also guarantees the user balance is added from the bottom up to the Merkle tree root to record total assets for all users. Instead, we use the full 32 bytes and make sure of one unique ID for every customer (which we compute based on each unique user ID on OKX).
Withdrawn auctions are counted as unsold properties when calculating the clearance rate. The family home at 13 Robinson Street was guided at $6 million, and eight parties registered to bid, though only three took part in the auction. So far the exchanges that have announced they will publish their PoRs are Binance, Bitfinex, Bitget, Bybit, Crypto.com, Deribit, Huobi, KuCoin, OKX, and Poloniex. In this article, we’ll look at how proof-of-reserves techniques aim to help, how they work, and some examples in action. An algorithm is a set of well-defined instructions used to perform calculations, accomplish a task, or solve a problem(s). The instructions must be executed in a specific order to produce the desired outcome.
Chainlink Labs launched another approach in 2020 to help projects across Web2 and Web3 ecosystems prove asset reserves through automated verification. By connecting to an exchange’s API, vault addresses, and proof-of-reserve smart contracts, it automatically and independently determines if its reserves are equal to or greater than its deposits. The crypto industry clearly needs a better way to prove the safety of customer deposits independent of external parties to maintain its decentralized approach while complying with financial regulations. But until recently, there was little urgency in deploying widespread solutions to increase trust among customers and users. However, November 2022 saw the most remarkable example of centralized exchange insolvency. Sam Bankman-Fried’s FTX cryptocurrency exchange famously crumbled after Alameda Research’s (FTX’s sister trading firm) balance sheet was leaked to the media.
This allows them to verify that the leaf matches the same Merkle root that was disclosed. Prove onchain and offchain collateral reserves to help mitigate risk and protect users from unexpected fractional reserve activity. Exchanges can also use Chainlink’s system to provide security around the guarantees that they cannot issue more tokens than assets stored in reserves. Paste and save the data as a JSON file, then run the Merkle Validator open-source OKX verification tool.
In effect, proof-of-reserves brings crypto exchanges closer to the treasuries of decentralized finance protocols, where all funds are matched to cryptocurrency wallets that anyone can trace on-chain at any time. Additionally, DeFi products can be constructed around this data, allowing users to hedge against the fractional reserve activities of traditional off-chain institutions. A Merkle tree is a cryptographic tree in which every "leaf" (node) is labeled with the hash of a block of data.
