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How Proof-of-Reserve Can Empower Cryptocurrency Transparency

Author: Alan W. Date: January 11, 2023

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The downfall of FTX in late 2022 has placed CEXes under the microscope of the entire crypto community. As a result, multiple exchanges have published their own merkle-tree proof-of-reserves to provide user asset verification and auditing. This is certainly a step in the right direction for overall industry transparency, but some believe that proof-of-reserve by itself is not enough to assuage user concerns on the safety of their digital currencies. It’s imperative that centralized exchanges figure out optimal best practices to increase trust on crypto asset verification.

Is Proof-of-Reserve Enough to Build Trust and Transparency? 

Proof-of-reserve is a method by which a custodial crypto platform verifies that it does indeed possess the digital assets required to back all user funds and deposits. Valid PoRs grant depositors peace of mind that their assets are safe and can be successfully withdrawn risk-free because they are accounted for within the exchange’s reserves. Unlike the traditional banking system which often runs on fractional reserves, CEXes must safely hold the entirety of their traders’ funds at all times to eliminate the risk of a bank run given the highly volatile nature of crypto markets. In the last several months, most prominent exchanges have published their proof-of-reserves with varying methods of execution.

Transparent Verification of Solvency for Cryptocurrency Exchanges

The Phemex proof-of-reserve tool takes a unique approach by incorporating an innovative self-proving mechanism which allows each user to independently verify their funds themselves without having to blindly rely on a third-party auditor. Our Merkle-tree cryptographically displays where each user’s assets are recorded on the platform. Its legitimacy is consolidated by all users successfully verifying their account balance, because any faulty records would be exposed and merkle root deemed invalid.

Compared to certain other platforms, Phemex has gone one step further beyond proof-of-reserve. A portion of the crypto community has voiced concerns that PoR by itself is incomplete, so we have also issued fully transparent proof-of-solvency. This is done by allowing anyone to freely download data showcasing the platform’s total liabilities for user deposits. Such liabilities can be verified because merkle root and leaves information is also included. Additionally, Phemex publicizes a portion of the platform’s cold wallet addresses containing major coins such as BTC, ETH, USDT, and USDC. These wallets are only dedicated to deposited funds, so a clear distinction is made between customer assets and platform assets. By granting visitors access to the exchange’s asset and liabilities data in real-time, we enable them to personally audit platform solvency at any time and eliminate the potential for financial manipulation.

Therefore, Phemex empowers a user to not only verify their own assets via proof-of-reserve, but also to constantly confirm that the exchange indeed has the funds available to accommodate all liabilities even in the event of a bank run where everyone wants to withdraw. While several larger exchanges have not yet done so, Phemex has already received certification from both Coingecko and CoinMarketCap on the legitimacy of our proof-of-reserve mechanism. Despite the trust surrounding CEXes dipping in recent months, Phemex still exhibits an unwavering commitment to transparency and cryptocurrency regulation.


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