Proof of reserves is getting better, but it still has problems, and not all of them are technical.

Proof of reserve (POR) has gone from a buzzword to a roar in recent weeks as the crypto world tries to get over the shock and losses of the crypto winter. After a lot of talk and work, criteria and rankings for what makes a good POR are starting to take shape. However, the details of how to do proof of reserves or even who should do it are still up in the air.

It was quickly made clear what the difference was between proof of assets and proof of reserves, as well as what was wrong with each one on its own. Traditional auditors’ attempts to give POR were quickly thwarted by big firms that stepped up and then quickly backed down.

Doug Schwenk, CEO of Digital Asset Research (DAR), told Cointelegraph that auditors may never be able to give users the peace of mind they want from PoR. Audits are done every so often, but cryptocurrency trades all the time. “In an ideal world, you’d be able to measure these liabilities and assets in real time,” he said.

DAR gives big firms traditional finance information and helps them check it out. It also contributes to the FTSE Russell index, which is traded on the London Stock Exchange.”We like to see proof of reserve.” […] “It’s not enough to make us say we’re happy, but it’s better than nothing.” He added:

“In the world we live in right now, sometimes better than nothing is a good place to start.”
To make things even more complicated, centralised (CeFi) and decentralised (DeFi) platforms have very different problems to solve. Amit Chaurhary, head of DeFi research for Polygon, a scalable blockchain ecosystem that works with Ethereum and is compatible with Ethereum, says that “proof of reserve is worthy of being called proof of reserve” because it is honest.

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Related: Proof-of-reserves: Can reserve audits prevent another FTX-like moment?

Chaudhary told Cointelegraph that the zero-knowledge Ethereum Virtual Machine (zkEVM) that the company is working on gives Proof of Reputation “battle-tested security.” This software uses Merkle trees to show both positive (asset) and negative (liability) balances. This makes it easy for a user to check their accounts while keeping their privacy safe. Zero-knowledge protocols can also offer dual collateral control for more secure settlement as well as anti-money laundering (AML) and know-your-customer (KYC) controls while keeping people’s identities secret.

Because the blockchain record cannot be changed, the audit process could be scrutinized.Chaudhary added:

“On your zkEVM, you can set up an accounting system. “You can come up with your own way to keep track of money.”
CeFi is a lot harder to deal with. “Since liabilities could be made off-chain, there is no way to show proof-of-liabilities and that a company can pay back all customer deposits,” Matthew Niemerg, the founder of the Aleph Zero blockchain, said in a statement to Cointelegraph.

Centralized cryptocurrency exchanges are taking different steps to offer PoR that meets the needs of their users. OKX has recently promised to give out a new POR every month. Its PoR is based on an open-source Merkle tree protocol and is displayed on a Nansen dashboard. Nansen lets third parties track transactions in real time.

OKX told Cointelegraph in a statement that the exchange verifies its holdings of its top three assets, BTC, ETH, and USDT, using a Merkle tree. This lets users verify their holdings, check that their balance is included in the exchange’s total liabilities, and compare OKX’s assets and liabilities.

“OKX makes its wallet addresses public through the Nansen dashboard,” OKX said. This lets users check their OKX holdings in real time “to make sure that OKX has enough reserves on-chain for users to withdraw.”

Even though OKX and other exchanges try to be open, “no amount of math or cryptography can solve the human problem of deceit and fraud, even if the books are audited by trusted, independent third parties.” “Garbage in, garbage out!” said Niemerg.

Culture is part of the problem when it comes to providing transparent services. Schwenk said that traditional finance has the “benefit of living in 2022, when capital markets have been highly regulated for almost 100 years.”

The DAR wants to “apply the same rigours as regulators” to “the kind of firms that are used to having a high degree of confidence in their counterparty.” Still, “it is impossible to get perfect information about any of these counterparties right now,” Schwenk said, because many of them are still working through maturity issues and aren’t as organised as they are in traditional finance.