Proof-of-funds aims to supplant exchange reserve reports

The concept of proof of reserves was introduced to address the growing need for transparency among firms managing digital assets on behalf of investors. This method is now set to be updated as institutions look for advanced tools to monitor and audit on-chain assets in real-time.

Web3 companies are poised to leverage this shift. For example, Tres, a financial data platform, is introducing a proof-of-funds system that provides automated, real-time snapshots for cryptocurrency exchanges and custodians.

Tal Zackon, co-founder of Tres, explained that exchanges currently monitor only the wallets in their co-mingled omnibus accounts. This approach provides only a snapshot of these wallets' balances and could be susceptible to manipulation.

Proof of reserves allows exchanges to demonstrate that they have enough assets to cover customer deposits, thus addressing concerns about insolvency and mismanagement. The collapse of FTX in November 2022 underscored the need for effective asset monitoring and increased calls for transparency regarding how exchanges manage user funds.

Nevertheless, the industry still struggles with a lack of standardization. Zackon noted that previous methods did not effectively create a reliable audit trail or offer validated trust to customers.

For instance, Binance’s proof-of-reserves page asserts that users' assets are fully covered, but many of its corporate assets are kept in wallets not included in its reserve calculations. Conversely, Kraken's approach involves snapshotting spot balances for selected assets like Bitcoin, Ether, ADA, DOT, XRP, and certain stablecoins.

Zackon highlighted that while manual tracking of real-time balances is feasible, the real challenge lies in obtaining a complete audit trail and financial history.

On-chain monitoring solutions have existed for some time. Chainlink, for example, employs oracles for decentralized asset and liability audits for exchanges, and Glassnode offers tracking of exchange balances and on-chain data analysis.

As traditional companies increasingly adopt digital assets, there is likely to be a growing demand for standardized reporting with clear methodologies. According to Coinbase’s 2023 Institutional Investor survey, 64% of current crypto investors anticipate increasing their allocations over the next three years.

Zackon emphasized that for the crypto sector to advance, it must operate within the regulatory frameworks of traditional financial systems.

Source: https://cointelegraph.com/news/proof-of-funds-technology-replace-exchanges-reserves-reports