Proof of Reserves: What It Is and How to Check an Exchange's Reserves

Proof of Reserves: What It Is and How to Check an Exchange's Reserves

Proof of Reserves (PoR) is an exchange's report showing that its wallets hold at least as many assets as it owes clients. Exchanges began publishing such reports widely after the collapse of FTX in 2022.

After the Binance hack on October 29, the question of whether an exchange actually has reserves is back in focus. Let's look at how PoR works, how to check it yourself and where its blind spots are.

What Proof of Reserves is, in plain terms

The exchange does two things. First, it shows how much client money is recorded in its books, then it shows the wallet addresses where the coins are held.

If the wallets hold as many assets as the sum of client balances or more, the reserves are covered. The ratio of reserves to the exchange's liabilities is usually published for each coin.

How a Merkle tree works in Proof of Reserves

Publishing every client's balance openly is not an option. So the exchange assembles them into a Merkle tree, a structure where each balance becomes a hash and the hashes are combined in pairs up to a single root.

The root of the tree is published. Changing even one balance unnoticed is impossible: the root would immediately be different.

• each client balance is hashed together with an identifier
• the hashes are combined in pairs, level by level
• the result is a single root hash for the whole snapshot
• each client receives their branch and can recompute the path to the root

Some exchanges add zero-knowledge proofs (zk-SNARK) to the tree. They confirm that the tree contains no negative balances without revealing anyone else's amounts.

How to verify your balance in Proof of Reserves

Exchanges that publish PoR usually have a verification section in the user account. The process looks roughly like this.

• find the Proof of Reserves section in your account and the date of the latest snapshot
• check that the balance in the snapshot matches your balance on that date
• download your branch of the tree and check it with the exchange's open-source verifier
• make sure the resulting root matches the published one
• open the exchange's list of addresses and spot-check the balances in a block explorer

From what we see, most clients stop at the first step. Yet the whole point of PoR is that anyone can verify themselves and the addresses without having to trust the exchange.

What Proof of Reserves does not show

The main weakness is liabilities. The exchange itself decides what goes into the tree, and debts outside client balances do not make it into the report.

PoR is not an audit. An auditor checks the financial statements as a whole, including liabilities and internal controls, while PoR only shows a snapshot of assets against client balances.

Why arbitrage traders need Proof of Reserves after hacks

An arbitrage trader keeps money on several exchanges at once, and each of them is a separate risk. The Binance story shows both sides: even the largest venue can be hacked, but having reserves helps it cover client losses.

In our view, a recent PoR with coverage above 100% for the coins you need is a basic requirement for any exchange that holds working capital.

A hypothetical example

Hypothetically: an exchange declares client balances of 10,000 BTC and shows 10,400 BTC on its addresses. Coverage is 104%.

If a month later the balances are the same but the addresses hold 9,700 BTC, coverage has dropped to 97%. That is a reason to reduce what you keep on the exchange and look into the causes.

Checklist: how an arbitrage trader should check an exchange

• does the exchange have a PoR and how often is it updated
• can you verify your balance through the Merkle tree
• what is the coverage for the coins you trade
• are wallet addresses published and do the balances match
• does the exchange use an external verifier
• do not keep more on one venue than you need for your current trades

We believe PoR is worth checking not once a year but after every major market event. It takes a few minutes.

Our tools

When capital is spread across several exchanges, it helps to see prices on all of them at once and keep on each exactly as much as a trade requires. Our arbitrage screener keeps dozens of venues in one window, refreshes quotes every second and shows each gap together with the volume actually behind it. The spread calculator helps you check what survives fees, network costs and slippage at your size. The bot is fully manual. It never connects to your exchange API keys.

To test the tools on a live market, ArbitrageScanner offers one day of free access to the whole ecosystem.

FAQ (Frequently Asked Questions)

1. What is Proof of Reserves on a crypto exchange?

It is an exchange's report showing that its wallets hold at least as many assets as the sum of client balances. It usually comes with a Merkle tree so you can verify your own balance.

2. How do I check an exchange's Proof of Reserves myself?

Find the PoR section in your account, check your balance in the snapshot, verify your Merkle tree branch with the verifier and spot-check the balances on the exchange's published addresses.

3. What is a Merkle tree in Proof of Reserves?

It is a structure where client balances are turned into hashes and combined in pairs up to a single root. If any balance changes, the root changes.

4. Is Proof of Reserves an audit?

No. PoR shows assets against client balances on the snapshot date, while an audit checks the financial statements as a whole, including liabilities and internal controls.

5. Why does Proof of Reserves not guarantee an exchange is safe?

PoR does not show all liabilities, pledged collateral or the state of reserves between snapshots. It also says nothing about how well wallets are protected against hacks.

Conclusion

Proof of Reserves is a useful but limited tool. It shows that reserves cover client balances on the snapshot date, but it does not reveal all of the exchange's liabilities and does not replace an audit.

Arbitrage traders should verify their balance through the Merkle tree, check coverage for the coins they trade and not keep more on one exchange than their current trades require.

IMPORTANT! We are software developers. We do not give recommendations or promises of earnings and we do not advise you to invest your money anywhere. Our software is fully manual, all your money stays under your own control. We show examples of how our clients have earned on arbitrage in the past, but we do not advise repeating those actions one to one. Your earnings depend solely on your own actions and on market factors.