Announcing Hacken’s New Service: Proof of Reserves (PoR) Audit

Hacken is launching Proof of Reserves (PoR) Audit — an external review of exchanges’ on-chain funds and liabilities for a true assessment of solvency and collateralization.

What is Proof of Reserves?

Proof of Reserves is an independent audit by Hacken that aims to ensure that the on-chain holding of cryptocurrencies by exchanges matches up with liabilities. A credible auditor verifies the crypto exchange’s on-chain funds against liabilities to assess collateralization.

The three essential elements of a Proof of Reserves Audit are as follows:

1. Public disclosure exchanges’ assets.
2. Merkle-tree verification. See how each transfer is stored on a cold wallet.
3. Audit of liabilities. We use auditing methodology to ensure that the records are complete, valid, and free from manipulation.

Proof of Reserves is the first step towards transparency in the market. It can even be close to real-time. Everything depends on the willingness of the exchange to share data because exchanges determine how often to publish an update on reserves.

Proof of Reserves is the New Push for Transparency

Recently, we had FTX collapsing almost overnight. Valued at $32 billion, FTX was one of the most stable exchanges. Crypto insiders considered it a “blue chip.” Now, it’s’ wholly gone. Dozens of thousands of users lost their deposits, and the industry struggles for mainstream credibility. VC funds that had a stake in FTX said goodbye to their investment. Why did this happen? Simply speaking, FTX leaders channeled funds to Alameda, a trading firm associated with FTX’s’ founder, and effectively “gambled” with their users’ funds.

This was a complete failure of corporate control. FTX did not keep appropriate books and records. FTX was one of the biggest centralized cryptocurrency exchanges, with a massive PR presence in the traditional media. If things like that happen to the most prominent companies, what sorts of dangers are hidden in publicized Web3 projects? We have no data on assets, liabilities, and net cash positions. The only way forward is to demand CEXs prove their solvency.

Proof of Reserves will be a new norm

The first Hacken’s research on Proof of Reserves dates back to 2019. The push for transparency is gaining momentum. Vitalik Buterin wrote an article about proof of solvency as a road to a safe CEX. According to Ethereum’s creator, it’s possible to solve transparency with proof of solvency.

“Exchanges could create cryptographic proofs that show that the funds they hold on-chain are enough to cover their liabilities to their users”

Vitalik Buterin

Vitalik believes that the proof of reserve is the easiest way for custodial exchanges to improve safety. In his view, proof of reserve consists of proof of assets and proof of liabilities. Hacken’s Proof of Reserves audit includes these two elements. Vitalik also hopes all exchanges will become non-custodial in the future.

Changpeng Zhao also addressed the need for proof of reserves.

“All crypto exchanges should do Merkle-tree proof-of-reserves. Binance will start to do proof-of-reserves soon. Full transparency.”

Binance’s CZ

CER.live added a Proof of Reserves rating. It already has Merkle-proof data for Kraken and Gate.io; more exchanges to come. Our partner CoinGecko added Reserves Tab to the exchanges’ profile page. Nansen and DefiLlama provide data on assets or reserves. Right now, crypto exchanges disclose the data voluntarily, but this will be a new norm, “If they can’t show the client’s funds – they are frauds!”

Proof of Reserves for Crypto Exchanges

Right now, crypto exchanges are a black box. You deposit money to the platform but have no idea where the funds go next. For long-term operations and mainstream adoption, cryptocurrency exchanges must engage in unprecedented self-regulating measures where they disclose their reserves. CEXs must prove their solvency to maintain trust.

The value of Proof of Reserves Audit for exchanges:

1. Proves that on-chain funds are sufficient to cover customer liabilities,
2. Shows good faith by using self-regulating measures amid market chaos.
3. Meets the growing demand for assurance over digital asset reserves.

The Proof of Reserves Audit by Hacken can be completed in less than three weeks.

What other projects need a PoR audit?

Proof of Reserves will soon become a standard for custodians, exchanges, lenders, and stablecoin issuers. Its goal is to ensure that these platforms do not engage in secretive financial transactions that put their customers’ funds at risk.

PoR has the power to bring transparency

“As the trend on Proof of Reserves audit is only at the beginning, you can be one step ahead of other exchanges and complete it one of the first with a help of Hacken” 

@buda_kyiv

Proof of Reserves is the first step towards eliminating unfair practices in the crypto industry. It verifies if client liabilities are reflected in tokens — no other way to guarantee that the platform doesn’t gamble with your funds. Hacken has a vision of bringing trust and transparency to the industry. Our ambitious goal is for every crypto exchange to verify each cryptocurrency position.