Proof of Reserves (PoR): Rethinking The Exchange-User Dynamic

As we approach the end of 2023, the crypto industry continues to evolve, with significant developments reshaping the landscape. The bearish streak that plagued much of 2022 and early 2023 seems to be a thing of the past, with Bitcoin prices soaring above $44,000 by December 2023, buoyed by the anticipation of a spot ETF approval. However, the shadow of the FTX saga, culminating in its bankruptcy announcement on Nov 11, 2022, still looms large, making the concept of proof of reserves (PoR) more relevant than ever.

What exactly is PoR, and why does it matter?

Key Takeaways:

• This advanced cryptographic accounting procedure uses a structure called a Merkle Tree.

• Bybit has recently extended its proof of reserves to include 32 digital assets. 

What Is Proof of Reserves (PoR)?

In simple terms, proof of reserves (PoR) refers to a verification method to prove that an exchange maintains its users' digital assets. This advanced cryptographic accounting procedure uses a structure called a Merkle Tree, which breaks down complex data into smaller, more digestible chunks for faster and more efficient processing.

The end goal is to ensure that the exchange is financially stable, and carries an amount either equal to or greater than the sum of the clients' balances.

Why Proof of Reserves Is Important

Ensures 100% Transparency & Protects Client Assets

Laying everything on the table deters a crypto exchange from making secretive financial transactions, such as loaning out more money than the collateral it holds and risking insolvency. In doing so, the clients’ assets are protected as well.

Helps Exchanges Gain Users' Trust

Proof-of-reserve audits provide an unbiased and completely honest picture of a crypto exchange's funds/financial backing, thereby helping users make more informed decisions. The presence of a PoR reassures users that their money is backed by real assets — while a larger user base translates to greater potential profit, making it a win-win situation.

The Trigger: FTX's Collapse: What Is FTX, and What Happened?

On Nov 2, 2022, the balance sheet of one of the biggest exchanges in the world — FTX — was leaked. With it came the revelation that its funds/reserves consisted largely of its native token, FTT. The issue is that FTT is printed directly by FTX and Alameda Research… Meaning the value of the exchange was likely to have been inflated, with many misled into thinking FTX was doing better than it actually was.

Due to unspecified “recent revelations,” Binance CEO Changpeng Zhao said his firm would liquidate its holdings of FTT. A stop was put to FTX withdrawals on Nov 8, 2022. The same day, Binance offered to buy out FTX, but withdrew its offer the very next day. On Nov 11, FTX officially announced that it had filed for Chapter 11 bankruptcy in the U.S., with its CEO Sam Bankman-Fried resigning from his position.

Due to Solana’s association with Bankman-Fried and his firm, Alameda Research, the price of SOL also took a beating. In November 2022, 1 SOL token was valued at less than half of what it was in October 2022, tumbling from the $30 range to around $13.

So ... Is a Proof of Reserves Necessary?

Since FTX announced its bankruptcy, the crypto industry plunged into a state of frenzy. In a bid to soothe frazzled nerves, crypto exchanges worldwide — including Coinbase, Binance and Bybit — have made their Merkle tree reserve certificates public.

In a tweet dated Nov 9, 2022, Ben Zhou, CEO of Bybit, reassured clients that Bybit has always [been] committed to client fund safety and guarantees 1-to-1 reserves.

To show its commitment to transparency and risk management, Bybit announced on Dec 20, 2023 that it has expanded its PoR attestation to cover 32 cryptocurrencies.

Bybit’s PoR Attestation

• Collateralization Range: Bybit's collateralization for these 32 assets ranges from 100-124%, with specific figures like 107% for BTC and 119% for ETH.

• Wallet System: Bybit employs a sophisticated multi-tier wallet system, including cold, warm, and hot wallets, enhancing the security and accessibility of user funds.

• Industry Ratings: Bybit has received top industry ratings, including a perfect score from CoinGecko and an ‘AA’ rating in the 2023 CCData Crypto Exchange Benchmark Report.

Bybit's expanded PoR is not just a singular achievement but a benchmark for the entire industry. It demonstrates a proactive approach to addressing user concerns post the FTX collapse and sets a precedent for other exchanges to follow. Bybit's initiative in extending its PoR to such a comprehensive range of assets, coupled with its robust wallet infrastructure and high industry ratings, positions it as a leader in fostering trust and transparency in the crypto exchange space.

Looking Ahead (2024 and Beyond)

Bybit's expanded PoR initiative marks a significant step forward in the crypto industry's journey toward greater transparency and user trust. By covering a wide range of assets, maintaining high collateralization, and employing a sophisticated wallet system, Bybit is not only securing its platform but also setting a high standard for others in the industry to emulate. 

As the crypto market continues to evolve, such initiatives will be crucial in building and maintaining user confidence. However, it's crucial for investors to understand that PoR is just one aspect of assessing a crypto platform's trustworthiness. In light of recent industry upheavals, transferring assets to hardware wallets (cold wallets) for added security and staying informed about protective measures remain prudent strategies.

Overall, proof of reserves is just one criterion with which you can assess the trustworthiness of a crypto platform. As the saying goes, an ounce of prevention is worth a pound of cure. We encourage you to be proactive by reading up on ways in which you can protect your cryptocurrency.

#Bybit #TheCryptoArk