Proof of Reserves – Establishing Best Practices to Build Trust in the Digital Assets Industry
May 4, 2021
Background: As the digital assets industry has developed, both consumers and institutional investors have relied on large custodians, exchanges, and other intermediaries to custody their assets. These intermediaries are entrusted with maintaining adequate digital asset reserves to meet customer liabilities (those digital assets the exchange or custodian holds for its customers).
The Problem: The growth of the industry has resulted in uneven and inconsistent methods for proving the existence of reserves to meet customer liabilities. Investors and customers need assurance that their funds are properly managed. Digital assets by their very nature offer built-in transparency but, until now, the innate cryptographic auditability of these assets has been woefully underutilized, despite the low technical barriers to doing so.
Bottom Line: At the end of the day, this is a very simple concept, that custodians need to be able to prove that they are indeed holding the assets that their clients have entrusted to their care. This is called Proof of Reserves (PoR).
PoR involves comparing on-chain assets held in reserve to off-chain liabilities. In other words, it empowers consumers to audit digital asset reserves held by a custodian on demand. But, despite a flurry of interest in 2015 in the wake of the failure of Mt. Gox, Proof of Reserves has failed to gain widespread adoption. Why would such a valuable practice be so infrequently and inconsistently applied, despite its benefits in promoting and maintaining industry trust and growth?
Our Proposed Solution: Here at the Chamber of Digital Commerce, we’ve been working to frame a consistent, industry-wide standard for Proof of Reserves to increase the confidence level of consumers, policymakers, and regulators that exchanges and custodians are managing their assets appropriately. We have created a comprehensive Best Practices resource to serve the industry with practical guidance on the core concepts of Proof of Reserves and implementation. The Best Practices, documented in this robust Practitioner’s Guide, brings together a diverse group of key industry stakeholders and subject matter experts, including digital asset custodians, exchanges, and legal and auditing professionals. This marks the first time the industry has an actionable rubric for adopting this important standard.
The Impact: Proof of Reserves is a profoundly self-regulatory measure. Using this framework, firms holding digital assets on behalf of third parties can use this trust-generating procedure. Ultimately, if the industry takes advantage of the transparency afforded by digital assets, consumers will be better protected, intermediaries will benefit from transparent practices, and regulators will appreciate these proactive measures. Put simply, it’s a win-win situation all around, for consumers, industry, and government.
Conclusion: As the industry continues to mature, it logically follows that building Proof of Reserves into custodians’ core practices will result in greater market share as well as customer, institutional, and governmental trust. If these Best Practices are adopted, for the first time, digital asset firms will benefit from the actionable intelligence specifically tailored to their needs. This effort is an important first step to bringing Proof of Reserves the attention it deserves, creating further industry engagement around trust models, and advancing our shared stewardship of the digital and decentralized future.
We are grateful to the authors and contributors who worked tirelessly to develop these comprehensive best practices with respect to creating Proof of Platform Reserves, including Members of the Leadership Committee: Noah Buxton, Armanino LLP; Nic Carter, Castle Island Ventures and Coin Metrics; Patrick South, TRM Labs; and Salvatore Ternullo, KPMG.
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