What is Proof of Reserve (PoR)?

Blockchain technology continues to create its impact on the different sectors worldwide with its multiple values–based improvements. However, there still remain a lot of challenges in the cryptocurrency industry that needs to be addressed. The bankruptcy of several crypto exchanges and banks has made it important to have a profound audit mechanism for the industry. This is where the new concept of Proof Of Reserve (PoR) was brought to life by industry experts.

What Is Proof of Reserve?

Proof of Reserve (PoR) is an important concept in the blockchain ecosystem that highlights an independent audit process for verifying the concerned parties.  The PoR mechanism verifies whether or not the party has adequate reserves for backing the balances of the customers. In the case of cryptocurrencies, an auditor checks and ensures that the on–chain assets of the company shall not be less than 100% of the matching customer assets. Thus, it offers assures customers about the capacity for solvency and liquidity of the concerned company that holds their assets.

Major Highlight of the Proof of Reserve (PoR)

The concept of Proof of Reserves comes with some major highlights which are as follows – 

  • Custodial Assets have access and control of the user’s private keys which they can use at their own will.
  • Users can also obtain the details of their transactions executed through hot and cold wallets that are used by centralized custodians.
  • It also provides an aggregated impression of the total amount of assets that are there in the custody of the platform.
  • Users also get access to their balance funds when they withdraw the assets.

Working of the Proof of Reserve (PoR)

The Proof of Reserves majorly focuses on the auditing process that verifies the discrepancies in the account balances. 
Step 1: The PoR audit process begins with the auditor taking a snapshot of the balances of the institution and then the auditor arranges the balance based on the Merkle Tree system. Here, the custodial data is arranged in the form of a single data tree with branches of partitions. 
Step 2: The next step focuses on identifying the data pieces with the hash codes as this allows auditors to derive the Merkle root. The Merkle roots denote the single point of connection among data pieces in the tree. Thus, there one can recognize the individual account on the basis of the unique digital signatures which are matched with the Merkle tree records.   
Step 3:   The step involves signature verification which examines whether the balances of the individual are equal to that of the balances visible in the Merkle tree. Thus, through the Merkle tree, one can detect the changes in individual balances. As a result, it makes it evident that any modification made by the institutions can be easily detected.

Benefits of Proof of Reserve (PoR)

The immediate need for transparency in the operations of centralized crypto exchanges and custodians has created the need for the auditing process that the PoR mechanism provides. Thus, the concept of Proof of Reserve provides the following benefits.

  • It facilitates proper verification of asset custody and helps monitor how individual accounts are managed on the platform.
  • It ensures that the activities on crypto platforms are carried out with due diligence because the users also have the option to withdraw their investments in case of any discrepancies. 
  • It allows users to have easy access to the transaction records.
  • It improves the centralized custodian’s transparency and focuses on improving the user’s trust.

Final Words

Since most users prefer centralized custodians for the secure and faster execution of crypto transactions but such custodians have often been accused of misusing the user’s funds. In such events, the concept of Proof of Reserve (PoR) comes to the rescue with its multiple features. This will add a more refined approach to the blockchain development processes too.