Liquidity risks associated with cryptocurrency exchange services

What is a Merkle Tree Proof of Reserve?

"A Merkle Tree is a cryptographic tool that enables the consolidation of large amounts of data into a single hash which acts as a cryptographic seal that “summarizes” all the inputted data. The Merkle Tree Proof-of-Reserves thus provides assurance to users by enabling quick, easy verification of a large volume of data, which in turn promotes transparency of the data."

Source: News Direct, last revised 10 Nov 2022

Merkle Tree in Proof of Reserves

"In PoR, the auditor first takes an anonymous snapshot of all held balances on the exchange and combines them into a Merkle tree. Next, the auditor collects the customers’ digital signatures, verifying the balances against those stored in the Merkle tree to ensure that all assets are completely stored in the reserves.

If needed, customers can also verify that their assets are included in the Merkle tree PoR by comparing select data with the Merkle root.

Hence, through the implementation of a Merkle tree PoR, an exchange’s holdings can be made fully transparent to the public."

Source: Bybit, last revised 9 Nov 2022

Merkle Tree example 

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