The concept of Proof of Reserves started after the implosion of Mt Gox. Initially, only Exchanges were applicable to execute a Proof of Reserves. However, the application of Proof of Reserves has expanded to stablecoins, asset-backed tokens, ETFs and more.
“One man’s asset is another man’s liability”
Proof of Reserves exists because people use 3rd-parties to hold assets on their behalf.
The reasons for this are many. Perhaps we trust the 3rd party to hold the asset more securely than us, or the 3rd party can securitize the underlying asset, or maybe they are holding it as collateral for a financial transaction.
No matter the reason, the problem remains the same, how can we trust the 3rd party holding the asset? By verifying they continue to hold the asset with Proof of Reserves of course.
Asset/Liability Pairs
The key to understand, is that upon entrusting a 3rd party to hold an asset on behalf of another, an asset and liability pair is created. The 3rd party holds the actual asset, and at the same time, the 3rd party is creating a liability (i.e. an IOU) to the entity entrusting them with the funds.
For example, when a user deposits 1 bitcoin into ExchangeX, ExchangeX holds the asset of 1 bitcoin, and at the same time owes (i.e. creates a liability) for the user 1 bitcoin.
When things are going right, the assets held by the 3rd party should also be equal to or greater than the liabilities it has issued to those entrusting them with holding their assets.
Fundamentally, Proof of Reserves is an asset and liability matching exercise.
From Exchanges and Beyond:
The concept of Proof of Reserves started with proving customer assets and associated liabilities at exchanges. At the time of first ideation in 2013, Exchanges were one of (if not the only) type of 3rd party in the digital asset ecosystem. However, in the last decade+, many more 3rd parties have entered the industry, and with them their own unique asset and liability pairs that should be accounted for in a Proof of Reserves.
The Expansion of Proof of Reserves
Stablecoins, Asset-backed Tokens, ETF Issuers, Bridges, and more, all hold assets on behalf of their issuers and issue a corresponding liability upon deposit. Typically these liability IOUs are redeemable by the users for the original assets they have deposited. Here are just a few examples of how the concept of Proof of Reserves and “asset and liability matching” can be applied to many different use cases:
| 3rd Party | Asset (held by 3rd Party) | Liability (IOU owed to User) |
| Stablecoin Issuer | Fiat, treasuries, and cash equivalents held in a bank accounts. | Stablecoin Tokens issued on blockchains |
| Asset-Backed Token Issuer | Assets, such as precious metals, held in a vault. | Stablecoin Tokens issued on blockchains |
| Exchange | Digital Assets deposited by Customers | Account Balances on the Exchanges Database |
| ETFs | Digital Assets held in Custody | ETF Security Instruments Issued |
| Blockchain-to-Blockchain Bridges | Tokens deposited into a bridging contact on the “Base Chain” | Tokens issued from a bridging contact on the “Destination Chain” |
Interestingly enough, there’s no reason Proof of Reserves couldn’t be employed by non-digital asset companies, such a FinTech companies or even banks!
Evolution is Inevitable
The concept of asset and liability matching on a ledger has existed since cave paintings. From Babylon to Blockchains, accounting for assets and liabilities has evolved to use new technologies and be applied to different use cases as society progresses. LedgerLens augments the auditor with the tools you need to capture these new Proof of Reserve opportunities.
