Proof of reserves (PoR), a method cryptocurrency exchanges and other financial institutions use to demonstrate that they hold the funds they claim to have on deposit, is still in its infancy stage. However, it will continue to be tweaked to meet the standards of compliance and regulatory guidance as needed. The concept behind PoR is to provide transparency and to assure customers and regulators that the institution has the necessary assets to meet its financial obligations.
CPAs need to be aware that there are different ways to prove the existence of reserves, but generally, the most common PoR method is to have the institution provide cryptographic proof that it holds a specific amount of funds in a specific address. This proof is generated by a third-party auditor, which verifies that the institution indeed controls the private keys associated with the address in question.
PoR may help build trust and confidence in the institution, as it gives assurance to users that their assets held by third-party institutions exist. There have also been a few institutions that share their liabilities in a PoR audit for additional transparency. The ability to see a 1:1 ratio between assets and liabilities may help ensure that customer deposits are not being utilized for any other purpose.
Proof of reserves offers these benefits:
- Increased transparency and trust. Proving reserves can help build trust with stakeholders by providing a clear and verifiable depiction of the organization’s underlying assets and/or liabilities.
- Improved accountability. By proving reserves, organizations can demonstrate that they are responsible stewards of their customers’ assets.
- Enhanced reputation. Proving reserves can enhance the reputation of the organization among its stakeholders, customers and the public.
- Detection of fraud. Proving reserves can help to detect fraudulent activities and ensure that the company’s financial records are accurate.
However, some potential obstacles of PoR include the following:
- There can be significant costs and resources required to perform regular audits to prove reserves.
- The potential for errors or discrepancies to be found during the audit process could lead to negative consequences for the organization.
- Privacy concerns may arise if the process of proving reserves involves disclosing sensitive financial information or a company’s keys.
- It may not provide a complete picture of the company's financial health, as it only focuses on one aspect.
Despite comments by Paul Munter, chief accountant at the SEC, saying, “Investors should not place too much confidence in the mere fact a company says it’s got a proof of reserves from an audit firm,” according to a December Payments.com article, he also mentions that PoR only shows reserves, not liabilities, which would paint a better picture of a company's financial health. To date, only a handful of exchanges have shared a PoR with liabilities included. This will most likely increase as the space matures and as more clarity is provided to the cryptocurrency markets.