Proof of Reserves Falls Short in Ensuring Crypto Exchange Solvency

Four years after FTX's collapse, crypto exchanges have made significant progress in implementing proof of reserves, but this verification process still falls short in establishing an exchange's solvency. A customer can use a Merkle tree to verify that their balance contributed to the root without gaining access to anyone else's account, and newer systems add zero-knowledge proofs, which can confirm calculations followed a stated set of rules while keeping individual balances private.

Major platforms like Binance, OKX, Kraken, and Crypto.com publish different versions of this process, but these systems have limits. A Merkle tree can authenticate the records placed inside it, but it can't identify accounts omitted before the tree was built, nor can it account for a company's liabilities, which are recorded across internal databases, bank accounts, contracts, and corporate ledgers.

Crypto exchanges face a unique challenge in providing comprehensive financial information due to their complex corporate structures and global operations. A reserve page may refer to assets held across a global group without identifying which company owns each wallet, making it difficult to determine the legal entities involved and the jurisdiction applicable in case of insolvency.