Proof of Reserves (PoR)

Proof of Reserves is a transparency mechanism used by exchanges and custodians to verify they hold users' funds one-to-one in reserve, proving solvency without disclosing individual account details or compromising customer privacy.

Modern PoR implementations use Merkle Trees, where a cryptographic hash aggregates anonymized customer balances producing a single verifiable root hash. Independent auditors compare this root hash to the entity's on-chain reserve wallets to confirm full backing. Users can verify their individual balance is included in the total without revealing their holdings to other users.

The best implementations align PoR with SOC 2 Type II audit standards for cybersecurity and operational integrity, combining cryptographic proof with institutional assurance. However, PoR has limitations including inability to detect hidden liabilities, reliance on point-in-time snapshots rather than continuous verification, and potential manipulation through borrowed assets displayed only during audit periods. Effective PoR requires regular publication of proofs, independent third-party verification, inclusion of all asset types and liabilities, and integration with comprehensive financial audits addressing the full balance sheet rather than only asset side.