What is the Mechanism of Proof of Reserves?
As per the recent events happening in the crypto industry, it becomes so difficult for everyone to believe in the security measures of cryptocurrency assets. Proof of reserves is a criterion that handles the transparency measures on assets held on the exchanges. However, it is the most important feature added to the transparency protocol for cryptocurrencies used as a vetting technique to make sure that crypto is not welcomed back to the real estate field as well. If you want to gain significant exposure to the popularity of digital currency, bitcoin is a great investment.
However, the techniques used in the Proof-of-Reserves are Markle trees which is a data structure that is scheduled to encrypt blockchain data structure as it is designed to encrypt the security of data of the blockchain safely and securely.
Significant proof of reserve mechanism
One of the incidents recently took place in the crypto industry where the market was dragged down by more than 10%. At a time when the sentiments of the investors are low and the market also showing evident suspicions so at that time the CEO of the Finance cryptocurrency has Mr. Changpeng Zhao proclaimed that the proof of reserves will be covered by them so that the transparency of the crypto assets could be audited for further clarification. This technique has swiftly attracted a lot of investor awareness garnering general support.
The audit working mechanism of Proof of Reserves
Initially Markle trees play a role to function as a third party so as to maintain a balance of data. After that, the accounts of all crypto were summed up and the balances of them were identified uniquely. However, the balanced accounts are then cross-checked on the public blockchains where digital signatures are mandatory for the use of assets. Ultimately the data of the balances and the detail of all the assets available on the public blockchain are verified and cross-checked. Although these numbers should maintain balance to ensure consistency. Moreover, some verification systems were also set up for the customers. If any changes were incorporated into the data that will be reflected in the market root which would suggest possible changes with the asset.
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Proof of Reserve Audit
Although several situations would occur when some bankruptcies were found in traditional financial institutions. However, these institutions were mostly bailed out by the governments. On the contrary, no centralised third-party involvement such as banks or government institutions took place in the case of cryptocurrency which would take them out from bail in such bankrupt situations. Hence the concept of Proof of Reserves results as the best option in both cases which is the transparency of the asset management along with the privacy provision of the customer assets.
Limitation of Proof of Reserve
The audit and confirmation of funds is however can be significantly executed by the proof of work protocol. But it includes some drawbacks as well. Proof of Reserve is reliable in case of control over on-chain data and also proves to be best with the funds being held but it is not able to verify the entire licence of a private key. Although there would be changes of conspiracy between the auditor and an auditee on which the audit is being executed. However, the responsibility to maintain the transparency of the data is equally distributed at both ends as key loss of stolen funds can show inconsistency during the verification process, and due to this, even the proof of reserve is not able to ascertain the verification process because if in case the funds have been borrowed by an exchange to pass the audit.