Proof of Reserves in Trading Platforms – What are they and what are they for?

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Have you ever wondered how to know if the Cryptocurrencies that you have deposited in an electronic trading platform are really there and are not used for other means? And it is that despite the fact that many platforms promise us that our Cryptocurrency balance is kept in personal wallets and where only we will have the ability to move or spend, we do not know for sure if this is really this way, or is it?

And it is that in recent years it has been shown that some platforms have begun to use a functionality that is widely used in some financial organizations and that the largest Crypto electronic commerce platforms have adopted to be more transparent towards their users.

This functionality is the Proof of Reserves, which is a test that basically allows the user to show if the Crypto trading platform where they have deposited their Cryptocurrencies really has sufficient assets or has the necessary liquidity to cancel its liabilities or obligations, without making use of the digital assets of its own users.

Let’s remember that this functionality is not typical of the Crypto ecosystem but was adopted from financial organizations that made use of this feature for greater transparency, and when we talk about the proof of reserves in Cryptocurrencies, a proof of reserves can be a document in which which shows in detail the assets guarded by a Crypto trading platform or a company.

As we already mentioned, it is a fundamental tool to give users greater transparency and through it allow them to verify where their funds really are. Thanks to the fact that many platforms are implementing this practice, users will be able to immediately detect unusual behavior in any exchange or platform where they deposit their funds.

This new trend has become popular thanks to the eagerness of trading platforms to contribute to transparency within the ecosystem, in this way its users can have greater control of their investments by having a kind of demand deposit.

What are the Proofs of Reserves for?

As we briefly mentioned previously, reserve tests are used by Crypto asset electronic commerce platforms such as Exchanges, P2P platforms, Brokers, among others, in order to demonstrate to users the veracity of their status. financial, where more than anything else it allows you to see if said platform has a sufficient balance to cancel its obligations or debts without using the funds of its users, but sometimes it is not as simple as this.

Currently some platforms are strongly committed to demonstrating the health of their finances. This is why an effective reserve test goes beyond showing the balance in the platform’s wallets. It is of vital importance that the organization can demonstrate to its users that they have the necessary financial liquidity to meet their obligations and commitments, as well as have the ability to allow the verification of the users’ balance and that these funds have not been used for other purposes without the consent of the owner, and all this without compromising the anonymity or privacy of the users.

An important fact of the Proof of Reserves is that they are very focused on the philosophy of the Crypto ecosystem, and that is that “we should not trust but verify”. If we focus on Bitcoin, we will see that it also contemplates this philosophy, where a person with an internet connection can check or verify the route that a transaction carried out within this network has followed, since that bitcoin is issued until its last destination can be verified. With this, it is sought that users do not have to trust the information provided by a third party and do not have any type of guarantee that said information is altered.

This is why the implementation of Proof of Reserves is so necessary in the context of online Crypto asset trading platforms.

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Types of Proof of Reserves

Currently, many platforms have implemented their own reserve test, but something that must be clear is that not all of them are the same or provide really relevant information to verify funds.

Simple Reserve Tests

They are basically the simplest test that a platform can implement, this consists of publishing a list of addresses in some Cryptocurrency that are directed to one or various Wallets and that are presumed to be from the company, the idea is that anyone can prove that the balance reflected in these portfolios is sufficient to cover the obligations of the platform.

Sometimes it goes a step further and an external auditor is hired to guarantee the control of the company with the listed wallets, as well as the verification of the company’s liabilities and that obviously these do not exceed the balance reflected in said addresses.

BIP-127 test

Currently this test is still in development, but it is still a very reliable way to verify the funds of an exchange without compromising the total balance of the users or their privacy. It consists of revealing how many Bitcoins a platform can spend, and this is done through a transaction that tries to spend all the UTXOs (unspent transactions) of one or several wallet addresses, but assigning an erroneous entry, so that said entry invalidates the transaction but reveals the total amount of Cryptocurrencies that can be spent, or looking at the available balance from another perspective.

Solvency Test (Merkle tree)

It was a test devised by Vitalik Buterin, one of the co-founders of Ethereum. This solvency test focuses on the creation of a kind of unique database fed by the total information coming from all the deposits of an address or wallet in a structure known as a Merkle tree, in this way any user can verify if your balance is included in this “database”.

In order to guarantee privacy Buterin also proposed the implementation of the zero knowledge proof Zk-proof which is in charge of encrypting and securing the most delicate and compromising information, in this way and in conjunction with the Merkle tree, the level of veracity and privacy offered by this reserve test is increased.

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If you are a Cryptocurrency enthusiast, you will know that any type of verification in any process or platform is welcome within the ecosystem, since what is sought in this Cryptographic economy is to avoid blind faith with any body or system.

In theory, if this happens, it means that said platform or company is in a state of technical bankruptcy, where there may be several scenarios, one where another platform or company buys the company to be liquidated and somehow saves its operation or directly closes and harms directly to your customers and partners.

Not necessarily, but it is recommended that every platform have the most optimal functionalities and that they make their system as transparent as possible.

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