Big Players In Crypto Calling For Proof of Reserves For Transparency, But It Has Its Limitations
As a result of the recent shocking demise of FTX, cryptocurrency exchanges across the industry are pledged to demonstrate proof of reserves as a way to boost transparency.
However, some industry leaders warn users that proving reserves comes with limitations as well.
Understanding the limit
In his comments to Decrypt, Casa CTO Jameson Lopp stated that the main issue is the inability to prove the negative.
“Point being, you can’t prove that there aren’t more liabilities than there are assets,” he said.
In a previous tweet, he said it’s better to have proof of reserves than to not have it.
“Proof of Reserves is not a panacea. You’re still trusting the auditor’s attestation. You’re still hoping reserves exceed liabilities. But it’s better to have PoR than to not have it,” said Lopp.
Proof of Reserves is not a panacea.
You're still trusting the auditor's attestation.
You're still hoping reserves exceed liabilities.
But it's better to have PoR than to not have it.
— Jameson Lopp (@lopp) November 9, 2022
Some worry that these proofs will mislead users into a false sense of security if they aren’t aware of their limitations.
The “proof of reserves” consists of a snapshot-backed by a cryptographic proof with how many reserves a custodian has at any given moment utilizing the transparency of Bitcoins and other cryptocurrencies’ blockchains; this proves that exchanges or third-party custodians actually hold the money of their users.
Different Types of Proof of Reserves
It is important to note that there are various types of proof of reserves. Crypto analyst Nic Carter, who has championed proof of reserves for years, argues that the best form of proof of reserves includes reporting liabilities in addition to reporting reserves, so that the custodian’s financial position is clearly visible.
BitMEX, for instance, includes liabilities in its snapshots, while Crypto.com, so far, only shows its reserves.
As Carter admits, proof of reserves is not perfect, but it is crucial to improving the industry.
“To those who reject [proof of reserves] because it’s not perfectly trustless in its current implementation, I would respond that the perfect is the enemy of the good. At present, the industry standard is virtually no transparency,” he said on his website.