What is Proof of Reserves? Does PoR make crypto more transparent?

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2022-12-03 12:36:28

As CHK Insights mentioned in the FTX event series, the failure of users to withdraw funds on this exchange is due to Sam Bankman-Fried (SBF) operating FTX as a commercial bank with a reserve mechanism. partial reserves.

The above mechanism plus Alameda Research’s weak liquidity is one of the reasons for the bank run on FTX.

You can read the series of articles about the FTX crash event for more related information:

Besides, as the boss of many different companies (FTX, FTX US, Alameda …), SBF used users’ money to conduct many “shady” transactions around these organizations.

Due to the lack of information transparency, users are completely unaware of these risks of FTX until it is too late.

Realizing that currently in crypto CEXs are units that lack information transparency, CZ has called on exchanges to focus on giving a list of wallets they are using to store users’ assets, a list. This is called by Binance Proof of Reserve (PoR).

Key Insights:

  • Proof of Reserves (PoR) is a list of wallets that an exchange uses to store users’ crypto assets.
  • Applying the Merkle Tree structure along with a third-party audit, users can check if their assets are backed 1:1 on the exchange (with updated data). continuously updated).
  • PoR will help centralized exchanges become more transparent.
  • PoR still cannot completely solve the same problems as the FTX event (if it happens) and the user’s assets are still put in jeopardy.

What is Proof of Reserves (PoR)?

Proof of Reserves (PoR) is a list of wallet addresses belonging to different blockchains that are publicly communicated by exchanges to the community. These wallets are where the exchange stores user funds.

This will be a solution to help users understand the total amount of assets being stored on the exchange as well as monitor large fluctuations in balance. From there they can infer the activities of the exchange and take measures to avoid (relatively) the same risks as the FTX event.

The PoR proposed by Binance also integrates the structure merkle tree to ensure data integrity and authenticity. Accordingly, thanks to the application of this structure plus third-party censorship, all users can check to see if their balance on Binance account has enough collateral.

Binance’s Merkle Tree PoR Implementation Process

If the exchanges fully implement the processes and have technical guarantees as well as a reputable third party auditor, it is likely that an event similar to FTX will not happen.

In case the exchanges fall into illiquidity or are in danger of bankruptcy (due to losing investments or bad debts), with the above conditions, users can still withdraw their funds normally.

From there, exchanges can regain users’ trust after a lot of drama surrounding FTX.

However, the question is whether PoR is enough to ensure the safety of user assets on centralized exchanges? This issue will be discussed later in the article.

PoR . tracking tools

You can monitor the PoR of the exchanges at the websites and information channels of that exchange.

There are also a number of other tools that aggregate and update PoR data of many exchanges, including:

  • Coinmarketcap: PoR will appear when clicking on the information of each exchange.
  • DeFiLlama
  • Coinecko: The Exchange Reserves section will appear when clicking on the information of each exchange.
  • Nansen Portfolio: In addition to the PoR of exchanges, this website also provides wallet addresses of many other projects.

As of now, according to data from DeFi Llama, there are 17 centralized exchanges that have announced their PoR. Some prominent names include Binance, OKX, Bitfinex, Crypto.com, Bybit…

CEX’s transparency issue after the FTX event

Currently, CEX is still the solution chosen by many investors to trade crypto because of their simplicity and convenient features. If we compare the trading volume between DEX and CEX, we can see that CEX is dominating.

dex to cex volume

When comparing the TVLs of all DeFi platforms (DeFiLlama, updated 11/29/2022), the amount of money users are depositing on Binance shows the overwhelming dominance of this #1 exchange.

defillama tvl defi

When comparing the TVLs of all DeFi platforms (DeFiLlama, updated 11/29/2022), the amount of money users are depositing on Binance shows the overwhelming dominance of this #1 exchange.

binance por

In addition, with questions raised about the disguised “hacks” of many projects, DeFi users still do not really trust this market and choose the solution of self-storage assets in personal wallets (despite being effective). capital use is zero).

Therefore, it can be seen that CEX is playing an important role in the development of the crypto market. If there are any risks in CEX, they are very serious and can have consequences for many stakeholders.

Centralized exchanges, in addition to acting as brokers, also perform many other activities such as investment funds, market makers (market makers), financial intermediation (credit activities)… Currently, these activities are not regulated by legal frameworks, so it is difficult to prevent conflicts of interest in these activities. of the same exchange.

Therefore, having a PoR that fully meets technical issues so that users can track in real time the number of assets to ensure the amount of assets displayed on their accounts is extremely necessary. .

This will protect the interests of users on the exchange to some extent, and at the same time improve the reputation of the exchange. In addition, users can quickly detect abnormal activities of the exchange if the wallets in the PoR have large balance fluctuations, thereby taking action before it is too late.

In addition, the FTX event has prompted the authorities to carry out investigations aimed at the crypto market, especially CEX exchanges. The introduction of PoR can help ease this situation.

But is PoR enough to solve the whole problem?

Is Proof of Reserve the optimal solution?

Is it enough just to give the host wallet address?

Many people think that PoR is just an activity that strengthens the trust of users and does not have much meaning in reality. Let’s go back to the FTX event – the origin of the birth of PoR.

“Drama” takes place because FTX takes money from users to use for other purposes (for Alameda loans, investments, etc.), FTX’s goal is to optimize capital efficiency or simply due to the situation. Alameda’s business is too weak.

As mentioned above, PoR allows users to soon realize the status of their assets on the exchange (whether they have been “gutted out”?) and the exchange’s abnormal balance changes. But that “early realization” still happens after the CEX exchanges have taken those actions (if any).

So from the FTX event, we can see that there are still three core problems in an exchange if the exchange falls into the same situation:

  • The exchange can still front-run users if they are really doing shady activities (because the exchange controls the private keys of the wallets).
  • PoR does not reflect the trading status of the exchange (the key factor leading to “gut out”).
  • The relationship between the exchange and organizations with different functions can easily lead to conflicts of interest, resulting in the above shady activities.

In short, assuming FTX has a pre-existing PoR, there’s a good chance they’ll still front-run users with measures like lockout. In addition, users know that their assets are not guaranteed 1:1 backed but still can’t do anything due to FTX’s poor business performance and complicated relationships of the exchange.

In this case, when it is discovered that PoR shows that their account is not backed 1:1, users will only be able to “be on guard” in part by withdrawing money in time and hoping to avoid the “storm”.

Therefore, it seems that PoR still cannot solve the whole problem of transparency of centralized exchanges today. There is even an opinion that PoR is just a solution to calm the authorities’ investigation of CEX exchanges after the FTX event.

Need more ingredients

The co-founder of an exchange Kraken thinks that PoR would be meaningless without including accounts with negative balances, like debt obligations. “The statement of assets is pointless without liability.”

It can be seen that, PoR is like a balance sheet cut in half, so it does not reflect the entire business situation and financial health of exchanges. It also makes no mention of cash flows between the institutions involved.

Furthermore, since exchanges often establish legal entities in “tax havens” and are not publicly listed, their financial statements (i.e. balance sheets are not cut in half) are not disclosed. public or even contain hidden funds.

Therefore, users will still have to believe that the exchanges are still doing well until the risk occurs. Therefore, in the future, it is not enough to use PoR to strengthen user trust, exchanges must be transparent with many other components to ensure the benefits for users.

Epilogue

Although it is not the optimal solution, nor has it solved all the outstanding problems in the transparency of CEX’s activities, PoR has laid the first bricks in protecting users of exchanges. .

In the future, PoR alone will not be enough. Exchanges still need legal frameworks to follow, as well as publicize their financial health and measures to protect customer deposits in the event of bankruptcy.



#Proof #Reserves #PoR #crypto #transparent

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