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Will the Information about the Reserves of Cryptocurrency Exchanges Help to Save the Crypto Market?

Feb 16, 2023 3 min read

FXT (short for “Futures Exchange”) collapsed in early November 2022. Before going bankrupt, it was one of the most prominent cryptocurrency exchanges. Its demise came about after CoinDesk published a report highlighting solvency concerns involving FTX-affiliated trading firm Alameda Research. Such a catastrophic event shook the entire cryptocurrency market, leading to a loss of billions of dollars in crypto assets. Most experts agree that the collapse of FTX will have repercussions on the crypto market for years to come.

FTX was a centralized crypto exchange platform that kept customers’ assets in custody besides offering coin swap services. The problem with FTX was the reckless use of customers’ deposited funds and a total lack of transparency. Customers had no idea about all sorts of things FTX was doing with their deposited funds. In the end, those things turned out to be disastrous, leading to FTX failing to satisfy customer withdrawal requests for the funds on the platform. Could such a scenario be prevented?

Proof of Reserves (PoR) Can Save the Crypto Market

Another event of similar proportions to the FTX collapse would seriously damage the crypto market. Some critics have argued that the existence of centralized exchanges poses a risk of such an event happening again. But realistically, decentralized exchanges will remain since their custodial service is convenient to many crypto users, particularly those with little experience with cryptocurrencies. A more viable solution is the implementation of Proof of Reserves (PoR).

In its simplest form, proof of reserves is an auditing technique to determine how many tokens a centralized exchange holds at a given moment. It must be performed so that there is little or no doubt about the exchange's solvency or lack thereof. One of the most common ways to perform PoR is through third-party audits by companies specializing in blockchain analytics. Companies like Chainlink can provide off-chain and on-chain proof of reserves.

Exchanges and Companies that Have Embraced Proof of Reserves

Proof of reserves might be the last resource to save the crypto market from the effects of situations like FTX, QuadrigaCX, or Mt. Gox. All these exchanges collapsed because of questionable fund activity, about which customers did not know anything. Hence, customers must be skeptical of a centralized exchange's services if it refuses to do PoR.

No wonder Binance, the world’s largest crypto exchange by trading volume, has shared its wallet balances. It will implement PoR soon. KuCoin, Huobi, Poloniex, Gate.io, OKX, Bitget, and other exchanges have committed themselves to conduct PoR shortly. Also, some stablecoin issuers will perform PoR to prove they have funds backing their cryptocurrency.

Final Thoughts

Proof of reserves is an auditing technique that could inhibit some events with long-term negative consequences for the crypto market. Simply put, PoR is a way for centralized exchanges and other crypto companies to prove they have what they claim to have. Is PoR the panacea? No. Audits depend partially on humans, and humans are prone to make mistakes. In many cases, auditing firms have failed to detect misuse of customer funds. However, PoR is the first significant step toward more transparency about the activities of centralized crypto exchanges.

Also, when a centralized exchange goes bankrupt, like in the case of FTX, customers can lose large sums of money. In some cases, individuals have lost a considerable percentage of their wealth. So, it is advisable to use non-custodial exchange services to prevent such a situation from happening to you. For instance, when you swap cryptocurrencies on LetsExchange.io, you control your assets at all times.


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