When cryptocurrency exchanges lack the resources to process consumer withdrawals, they risk going out of business. If you are a customer of a cryptocurrency exchange and have trusted the company with your coins, only to find out later that the exchange has lost all the money transferred through its platform, this is a serious problem.There seems to be a pattern among these companies in hiding or downright lying about their reserves. It is possible for an exchange, like FTX, to have used your money improperly to maintain its defunct trading operation. They might have unintentionally sent hundreds of millions of dollars in customer funds to another exchange, like Crypto.com did, or they might have completely lost everything in a hack, as happened to Mt. Gox.Even routine third-party audits or attestations might not be sufficient. The businesses may have deceived the auditors by moving money into the appropriate accounts just in time for the third party to tick the box indicating that the funds are in the proper location before investing it in riskier investments.Keep in mind that cryptocurrency exchanges differ from banks. To start, government depositary schemes do not insure cryptocurrencies. Customers must therefore exercise independent judgement when deciding where to park their money. They should review the terms of service to discover what assurances the exchange is providing regarding holding their funds. Even then, customers must have faith that the transaction will fulfil the promises made by those conditions.What if customers could genuinely follow the whereabouts of their money in real time?<h2 id="header-0">Let&#39;s introduce Merkle Trees and Proof-of-reserves.</h2>A sort of transparency known as proof-of-reserves is supported by many crypto exchanges. This cryptographic technique can be used by customers of a cryptocurrency exchange to show that the exchange has adequate liquidity to handle all customer withdrawals and to otherwise keep track of where their money is actually located.Merkle trees can be used as a tool in this process. As a result, &#34;hash trees&#34;—effective data structures that resemble a map of client funds and can be safely validated—are created. These structures continue to work even as the reserves get more complicated.After the issue of a proof-of-reserves certificate, anyone could track the funds and ascertain how much cryptocurrency an exchange holds. It acts as a legitimate verification system to prevent exchanges from stealthily taking money from its customers.Even though designs for proof-of-reserves typically call for the hiring of a third-party attestor to guarantee that the on-chain funds actually line up with what the exchange claims to own, on-demand, real-time tracking of exchange reserves would be an improvement over the current approach.Proof-of-reserves, which matches all funds to cryptocurrency wallets that everyone can track on-chain at any moment, effectively moves crypto exchanges closer to the treasuries of decentralised financial protocols.Following the demise of FTX, the concept of proof-of-reserves based on Merkle trees gained a lot of attention. Changpeng Zhao, the CEO of Binance, said through Twitter that his exchange would start implementing proof-of-reserves.Nine additional exchanges, including KuCoin, OKX, and Gate.io, made similar preparations after Binance disclosed its intentions. Others, like BitMEX, claimed they will attest to the reserves directly, while some, like Gate.io, chose auditor-assisted proof-of-reserve validation.Merkle tree-based proof-of-reserve would not completely prevent customer money from being stolen, to be sure. It merely keeps track of assets and does not prevent an exchange from offering dubious loans to borrowers with slim chances of payback, for example.Furthermore, proof-of-reserve does not give customers more control over their money; it merely provides information.A client would only have been able to observe their cryptocurrency taking a quick stroll over a cliff if FTX had implemented proof-of-reserve (in addition to its audited financials), but they couldn&#39;t have stopped it from happening in the first place.A proof-of-reserve is ultimately only as good as its verifier. A third-party attestor could nonetheless support a flat-out untruth by a crypto exchange. The entire objective of proof of reserve would be defeated if the attestant was dishonest or inept, maybe by failing to notice missing wallets or unable to comprehend how an exchange had organised customer holdings.

An Explanation of Proof of Reserves

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