Two major crypto exchanges, OKX and KuCoin, have announced that Proof of Reserves, also known as Proof of Funds (PoF), will be available within the next month. The announcement comes in the midst of the FTX liquidity crisis. Other than OKX and KuCoin, 7 exchanges have issued separate statements in the last 24 hours stating that they would publish their Merkle tree reserve certificates to increase transparency. Binance, Gate.io, Poloniex, Bitget, Huobi, Deribit, and Bybit are among them.
In an official tweet on November 9, OKX stated, "For #OKX, transparency, risk management, & consumer protection come first. We're hiring Armanino for auditing & will publish an auditable Merkle POF asap. Here are 23 BTC addresses (~69K BTC) & 13 ERC20 addresses (~ $2+ BN) as a 𝗽𝗮𝗿𝘁 of our reserves for users to verify."
For the uninitiated, every user's assets are recorded by the ledger of a centralised database in a centralised crypto exchange. The total amount of the user's assets is recorded in the database. Proof of Reserves is a technique used by some crypto exchanges to demonstrate that they have sufficient assets to handle all withdrawals. All customer balances are recorded and converted into a cryptographic Merkle Tree by a reputable third-party auditor.
A Merkle tree is a type of data structure used in computer science. Merkle trees are used to encode blockchain data more efficiently and securely in bitcoin (BTC) and other crypto assets. They are also known as 'binary hash trees.'
Binance CEO Changpeng Zhao recently suggested that crypto exchanges implement Merkle-tree Proof-of-Reserves. While traditional financial institutions such as banks can operate on fractional reserves, he believes that crypto exchanges should not. He said, "All crypto exchanges should do merkle-tree proof-of-reserves. Banks run on fractional reserves. Crypto exchanges should not.@Binance will start to do proof-of-reserves soon. Full transparency."
Kucoin CEO Johnny Lyu also stated that Proof of Reserves will be available 'in about a month.' He stated that Kucoin would collaborate with 'authoritative auditing institutions' to ensure that the Proof of Funds accurately represents the assets in circulation.
It is worth noting that using Merkle trees allows exchanges to store each user account's hash value of assets. The value is stored in the Merkle tree's 'leaf nodes.' The second step is to audit the assets in the Merkle tree's leaf node and have a third party verify all of the users' holdings. This anonymises the data to protect privacy. Further, it also allows users to compare total customer balances with total assets on hand at the exchange.
The writer is the founder at yMedia. He ventured into crypto in 2013 and is an ETH maximalist. Twitter: @bhardwajshash