Proof of Reserves, What Is It, and Is There a Need for It in Today’s Crypto Ecosystem?

| November 17, 2023

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Proof of Reserves

The cryptocurrency ecosystem is witnessing tremendous adoption. The rise in usage of blockchain applications and their native cryptographic coins and tokens is making the ecosystem mainstream and, more importantly, valuable. The values of some cryptocurrencies have skyrocketed since their inception and, ergo, are attracting several users. Whether the purpose of their use is for transacting or storing value – crypto assets are gaining the confidence of large scores of users.

The increased adoption of these assets is leading to the growth of centralized cryptocurrency-related businesses too. A business that has existed since the dawn of cryptocurrency is the custodial service. Ideally, crypto-custodians are third-party institutions that are entrusted by users for safekeeping of their crypto assets in a safe and secure environment. Apart from dedicated, standalone crypto custody services, centralized exchanges and trading platforms also act as custodians of funds parked by users in their respective accounts on their platform.

In the case of exchanges and trading platforms, each user’s assets aren’t stored separately but maintained in a common pool along with platform’s operational liquidity and reserve holdings. In recent days, a combination of mismanagement and volatile market conditions have led to few platforms finding their reserves falling short, barely covering the value of user assets in their custody. These developments have not only adversely impacted the crypto businesses, but also hurt the crypto-adoption rate with many users losing faith in the existing system. To alleviate the fears and regain their users’ trust, several custodians have started to present Proof of Reserves as an indicator of their platform’s health, assuring the community that their funds are safe.

What Is Proof of Reserves?

Proof Of Reserves (PoR) is a cryptographic measure to check if a cryptocurrency custodian holds the assets they are obliged to possess. Essentially, PoR audits attest to whether a cryptocurrency platform storing user assets is solvent or not. It is achieved by checking the liabilities of the custodian platform and comparing it against the assets held in the reserves.

The liabilities often refer to the cryptocurrency deposited by the platform’s users that are owed back to them upon request. Unlike banks and other institutions in the traditional finance world, cryptocurrency custodians are prohibited from lending or reinvesting the assets entrusted to them by their users.

Ideally, a custodian must possess assets in a 1:1 ratio with their liabilities. It indicates they are solvent and can honor every user’s withdrawal at any point. If their liabilities are larger than their assets, the custodian is insolvent. Such instances occur mainly because of the mismanagement of user-deposited funds. That is obviously a red flag considering that custodians are not allowed to use user-deposited funds to profit. The idea is to avoid any risks which can jeopardize user funds.

PoR helps identify whether platforms are indulging in risky activities. PoR audits are conducted by third-party firms mostly using cryptographic methods.

Proof of Reserves Audit, how is it Conducted?

A custodian’s reserve audit is ideally administered by reputed third-party firms, preventing deliberate falsification of results by the custodian. The audit firms mostly use the cryptographic Merkle tree approach to obtain details of the custodian’s liabilities. Merkle trees are cryptographic structures that allow storing large data sets while maintaining their integrity. The data in this structure is cryptographically hashed, thereby preventing any manipulation.

Using Merkle trees is an ideal way to audit each user’s account alongside the assets held by the custodian. To form a Merkle tree for a PoR audit, the audit firm takes snapshots of all user account balances that reflect their deposits. The data from the snapshots get hashed and added to the tree as its leaves. Each leaf represents the hash of each user account’s deposit data. The leaves are then combined in sequence to form branches which are hashed leaf bundles. The branches, further, are combined to form the root. The root represents the combined hash of every account data.

The cryptography involved in Merkle tree technology prevents the manipulation of any hashed entry in the tree – any change gets identified immediately as the root hash varies. It prevents anybody from falsifying user balances in the audit once performed and the Merkle tree gets formed. More importantly, all users can verify the state of their deposits on the custody platform and if the funds are held safely by the custodian.

While the custodian’s financial obligations get represented on the Merkle tree, the auditing firm further audits the assets held by the custodian to verify its solvency. The custodian must possess assets in its blockchain wallets mirroring the total deposits of its customers. The sum of all the wallets the custodian uses to store user deposits gets calculated. Furthermore, the custodian needs to prove the wallets are, in fact, held by them. That gets achieved by moving a specific amount of funds at a certain time as specified by the auditor.

Successful transactions from all the wallets claimed by the custodian prove that the custodian is solvent – provided that their sum equals the totality of user deposits. Wallet balances and the transactions initiated from the wallets for PoR purposes can be verified on blockchain explorers. The transparency facilitated by the blockchain combined with that achieved by PoR audits makes it possible to gauge the trustworthiness of cryptocurrency custodians.

How Proof of Reserves Help the Cryptocurrency Ecosystem

The increased transparency with which platforms can now operate will bring back trust. Users can confidently deposit cryptocurrency with platforms that frequently release PoR reports to the public. Logically, it will attract more users to use such services because of the increased safety. Additionally, because releasing PoR reports is becoming the norm, custodians should behave appropriately with user funds. The lack of the right amount of funds in custody or refusal to release PoR reports can result in users collectively abandoning those platforms.

The state of cryptocurrency platforms after the FTX meltdown is such, PoR audits will make storing crypto assets with third parties less worrisome and bring back trust in the larger cryptocurrency ecosystem. Centralized custodians and exchanges are still the first points of entry for most individuals wanting to use cryptocurrency. Their transparency is needed for the mass adoption of cryptocurrency.

Why Proof of Reserves Cannot Solve Trust Issues Alone

As PoR brings additional layers of trust to the cryptocurrency ecosystem, it is not the be-all and end-all. PoR audits, for one, cannot completely rid platforms of irresponsible behavior. The audits are, essentially, a snapshot of the assets held by custodians in contrast with their liabilities at that given point. They can still choose to behave how they want to once the audit is released.

Moreover, auditing firms must be competent enough to carry out such tasks. The audits are heavily reliant on the competence of the auditor. Custodians need to hire competent auditors to make sure the results are respected by their users and the cryptocurrency community.

However, the fact that custodians choose the auditors can bring other complications into play. What if the auditor conspires with the custodian to provide fake reports? The auditor can get paid off or might be financially invested in the custodian’s growth.

So, PoR audits cannot be treated as the ultimate solution to prevent custody platforms from indulging in shady behavior.

Proof of Reserves Can Be the Start of Making Cryptocurrency Usage Safer

PoR is becoming a growing measure for centralized cryptocurrency platforms to prove their solvency. In the wake of the infamous FTX collapse, preceded by many other platforms going insolvent, users want to know if the platforms they leave their funds on can be trusted.

PoR is an appropriate beginning to bring some order into the space. Although it is not adequate by itself, a combination of PoR with other safety and control measures enforced by regulators can become the perfect antidote. Together, they can counteract the consequences left behind by bad actors and bring trust to the centralized parts of the cryptocurrency ecosystem.

More on Crypto

As we continue constructing a fully regulated digital asset custody platform, ensuring secure storage for both crypto and fiat assets remains a critical priority. 

To facilitate the last checkpoint of enabling institutions to convert their digital asset treasury into fiat currency, we’re expanding beyond pure wallet infrastructure and integrating seamless fiat off-ramp capabilities for our partners.

We’re thrilled to announce our partnership with Encryptus, licensed and compliant off-ramp solutions tailored for institutional clients. This collaboration elevates Liminal’s service offerings by empowering our partners to convert their digital asset treasuries into fiat currencies efficiently.

Integrating A Seamless Off-Ramp Solution

The digital asset ecosystem historically faced friction points when transitioning between fiat and cryptocurrencies. Off-ramp solutions address this pain point by enabling efficient and streamlined conversion between asset classes, minimising value loss and simplifying compliance processes.

Here’s how off-ramp changes the game:

  • Reduced Friction: Frictionless conversion minimises delays and operational complexities associated with traditional fiat-crypto exchange methods.
  • Enhanced Efficiency: Streamlined workflows expedite asset conversion, increasing speed and cost-effectiveness for institutional and individual users.
  • Optimised Value Preservation: Advanced off-ramp solutions prioritise minimising price slippage and value loss during conversion, protecting user portfolios.
  • Simplified Compliance: Integrated compliance features navigate regulatory complexities, ensuring adherence to relevant financial regulations.

With our partnership with Encryptus, we have embedded their institutional-grade APIs, connecting their off-ramp solution within Liminal’s wallet and custody platform. 

This integration simplifies our clients’ liquidation requirements while keeping their assets secure and more:

  • Effortless Digital Asset to Fiat Conversion: Our partners will be able to access treasury management and facilitate business payments in 54 countries and individual payments in an extensive network of 80+ countries.
  • Streamlined Compliance and Regulation: Our partners will be able to leverage Encryptus’s rigorous licensing and compliance framework, ensuring adherence to stringent financial regulations.
  • Enhanced Platform Value: We will be able to expand the functionality of the Liminal custody solution, attracting institutional users seeking comprehensive digital asset management capabilities.

Moving Towards A Robust Off-Ramp Partnership With Encryptus

The partnership between Liminal and Encryptus earmarks a significant step forward in secure digital asset custody, representing a shared commitment to pushing compliant practices while supplying institutions with easy access to convert their digital assets to fiat. 

For Encryptus, the opportunity to integrate with Liminal’s established platform presents a chance to reach a wider audience and scale their innovative off-ramp solutions to new heights. By streamlining fiat conversion within Liminal’s secure custody infrastructure, Encryptus gains access to a trusted network of institutional users seeking seamless and compliant treasury management.

For Liminal, this collaboration reinforces our dedication to partnering with companies that demonstrably prioritise clear governance and robust policy frameworks. By aligning with Encryptus’s stringent compliance standards, we reaffirm our commitment to building a secure and sustainable future for digital assets, where trust and regulatory certainty go hand-in-hand.

January 22, 2024

Hello world, it’s that time of the month when we share the biggest security breaches in the world of Web3 through our Security and Regulatory Newsletter. 

Liminal believes in optimizing security and custody practices globally across the Web3 industry. Through our Newsletter, we highlight security, regulations, and compliance incidents that have happened in the past month and how one can follow better Security practices to safeguard their digital assets. 

We will also highlight regulatory changes that might have happened globally, which were significant to the overall ecosystem.

Dive in and get a detailed analysis of everything security and regulation in the domain of web3 with Liminal’s Monthly Security and Regulatory Newsletter.

Web3 Security Compromises in January

Abracadabra exploited for almost $6.5 million, Magic Internet Money stablecoin depegs

The Magic Internet Money ($MIM) stablecoin has lost its dollar peg again, dipping all the way below $0.77 in a flash crash before returning to around $0.95.

The depeg appears to be related to an exploit of the Abracadabra lending protocol, which allows people to borrow $MIM. An attacker exploited an apparent flaw in the platform’s smart contracts to drain around $6.5 million.

Goledo Finance hacked for $1.7 million

Goledo Finance, an Aave-based lending protocol, was exploited through a flash loan attack. The attacker stole assets estimated by CertiK to be around $1.7 million.

Goledo Finance contacted the attacker to offer a 10% “bounty” for the return of the remaining assets. In a message on January 29, the attacker wrote: “I hacked Goledo and want to negotiate.”

Socket service and its Bungee bridge suffer $3.3 million theft

The Socket cross-chain infrastructure protocol was hacked for around $3.3 million in an attack that exploited its Bungee bridge. The thieves were able to exploit a bug that allowed them to take assets from those who had approved a portion of the system called SocketGateway.

A little over 700 victims were affected, and the highest loss from a single wallet was around $657,000. 121 wallets lost assets priced at more than $10,000.

On January 23, the protocol announced they had recovered 1,032 ETH (~$2.23 million) of the stolen funds.

Web3 Regulatory Practices for January

The EU Imposes Stricter Due Diligence Rules for Crypto Firms

On Jan. 17, the European Council and the Parliament came to a provisional agreement on parts of the Anti-Money Laundering Regulation (AMLR) that now extends to the crypto sector.

Under the new rules, cryptocurrency firms will be required to run due diligence on their customers involving a transaction amounting to €1,000 ($1,090) or more. 

However, the agreement isn’t final yet as it has to be first officially adopted by the Council and Parliament before the rules can be applied.

So, after the EU passed its landmark MiCA regulation last year, which clarified rules about cryptocurrencies, regulators are now targeting the space with tighter controls. 

While these regulations bolster security and trust in the crypto market, potentially attracting more cautious investors and combating financial crimes, they also present challenges. 

The US State of Virginia Introduces Digital Assets Mining Rights

Recently, the Virginia State Senate introduced Bill No. 339, which outlines regulations for the transactions and mining of digital assets and their treatment under tax laws. 

The legislation exempts individuals and businesses engaged in crypto mining activities from obtaining money transmitter licenses. Additionally, it protects miners from any discrimination. 

Issuers and sellers of crypto are also exempted from securities registration requirements if certain conditions are met. Moreover, those offering mining or staking services are not to be classified as “financial investment” but must file a notice to qualify for the exemption.

The bill further incentivizes crypto’s use for everyday transactions by offering tax benefits. Under this, up to $200 per transaction can be excluded from an individual’s net capital gains or gains derived from using crypto to purchase goods or services, starting from Jan. 1, 2024.

Key Takeaways:

  • Hackers continue to exploit vulnerabilities in DeFi protocols and cross-chain bridges, highlighting the need for robust security measures.
  • Regulatory frameworks are evolving rapidly, with stricter AML rules and supportive legislation for emerging technologies like crypto mining.
  • Staying informed about these developments is crucial for navigating the digital assets market safely and responsibly.

Stay #LiminalSecure

These events highlight the constant evolution of Web3 security and regulation. You can confidently navigate this dynamic landscape by staying informed and prioritizing security best practices. 

At Liminal, we’re committed to empowering institutions to unlock the full potential of digital assets without compromising security or compliance norms with our robust custody and wallet infrastructure solutions. Join us on this journey towards a safer, more accessible future for digital assets.

January 15, 2024

Buckle up as we’re about to take a trip down memory lane. 

The year 2023 was a wild ride that showed signs of a plummeting market, groundbreaking innovation and regulatory hurdles. 

Contrastingly, in the same year, we saw no market-shattering crashes. Financial institutions extending an olive branch, key jurisdictions unlocking the doors to blockchain technology. 

Simultaneously, at Liminal, we experienced significant breakthroughs, re-engineering our positioning and becoming a pioneer in digital asset security with bank-grade custody. 

We took major strides this year, right from building comprehensive products to becoming a qualified custodian, from revamping our brand design to expanding our offices in newer locations, from partnering with hyper-local communities to onboarding a diverse set of clients,  we did it all. 

So, let us take you through everything we accomplished in 2023 and what the future holds.  

Liminal Became A Qualified Custodian

One of the prominent moves we made this year was to change our positioning as a regulated custodian from being a wallet infrastructure platform. 

We got two licenses in key jurisdictions to operate as a regulated custodian. 

The first one came from Hong Kong, where we acquired the TCSP license issued by the SFC, which oversees and regulates financial activities to ensure compliance with legal and regulatory obligations. 

Our next license came in the MENA region, where we got In-Principle Approval for the FSP license granted by the FSRA, a governing body in ADGM, to establish a progressive financial services environment. 

Both these licenses paved the way for Liminal to push its wallet infrastructure and offer bank-grade custody to institutions looking to operate in these particular regions. 

Liminal Introduced A Suite of Products & Features

Continuing our building spree, we launched new products and integrations to broaden the existing infrastructure and added more parameters of security, scalability and sustainability. 


Liminal launched staking for institutions to eliminate the risks involved in running staking nodes and the vulnerabilities in hot wallet transfer. 

Hence, we introduced an industry-first mechanism of cold wallet staking to ease staking for institutions and secure assets explicitly.  

Whitelabel Solution

Accelerating the go-to-market time for organisations looking to build a secure and customisable application, Liminal launched its whitelabel solutions

Targeted to help organisations meet security standards, manage assets with maximum control, and add their custom branding to give it a personal touch. Our whitelabel solution is a first-in-class custodian-developed solution for institutional grade custody.

Smart Consolidation

We are building not just secure custody but also automation-based features to eliminate manual errors, increase the throughput of transactions and scale institutional wallets. 

Taking this ahead, we launched the Smart Consolidation feature to automatically calculate all the active addresses and consolidate them into a single address. With this level of automation, managing multiple addresses becomes uber easy for wallet teams. 

Travel Rule 

To limit the use of cryptocurrencies for activities like money laundering and terror financing by regulatory bodies, travel rule was mandated for institutions to follow. 

Continuing the latest compliance integration policy, Liminal partnered with Notabene to introduce Travel Rule, enabling institutions to manage counter-party risk and extend the process of due diligence right from the Vaults dashboard.   

Liminal Accured List Of Security Certifications

Following our ISO certification for data privacy and risk management, we added two new security certifications to fortify our systems and build trust for our clients. 

Liminal Achieves Crypto’s Highest Security Mark: CCSS Level-3 Certified

Cryptocurrency security lacked a gold standard, creating a vulnerable ecosystem. Enter the CryptoCurrency Security Standard (CCSS), setting the bar for auditing and certifying custodian infrastructure and establishing levels of trust and confidence for investors. 

Liminal became only the second wallet infra platform and the first regulated custodian to be accredited with Level-3 certification, deeming wallets, transfer environments, workflows and engines safe and secure. 

Liminal Reciueved SOC 2 Type II Certification

To tackle threats in institutional-grade security, organisations’ SOC has been identified as the primitive compliance standard for service organisations to handle customer data.

Liminal successfully attained SOC 2 Type II certification, validating its setup of security controls & compliance processes to be industry standard. 

Liminal Level Up

Liminal unveiled its most significant platform upgrade ever, revolutionising the future design standard of a qualified custodian. This level-up activity included revamping our website and product UI, giving a completely new look and feel to not “Liminal” but “Liminal Custody”. 

The Liminal level-up activity was a strategic step and the biggest one for us this year to create an intuitive, inviting and tailored experience for our clients. 

Liminal Reached New Borders

We spread out our operations this year, reaching new borders and onboarding a new wave of institutions across gaming, DeFi, HNI wealth, treasuries, and exchanges! From Indonesia and Africa to India, UAE, and Korea, we are setting up custody operations worldwide. 

This isn’t just a roster of clients; it’s a network ready to spark connections, collaborations, and shared success to further the definition of secure assets. 

Liminal Collaborated With Law Enforcement Agencies

The best and the proudest moment of Liminal for this year was when we collaborated with CBI & Himachal Prashesh police department to aid them in seizing digital assets. 

This partnership put us on the map, as we became the first point of contact for LEAs in India, and we standardised the process of secure seizure of digital assets. Leveraging our expertise, we enabled a safe space for officers to learn the basics of custody, contributing to a safer digital landscape.

Team Liminal Grew Bigger

Building such a massive infrastructure, prioritising security and compliance over everything else, we had to grow the team to build at pace and expand at an even higher level. Not only did we grow in team numbers, but we also elongated our footprint to new destinations. 

Team Liminal went from 32 to 70 with 5 new offices in Mumbai, Ahmedabad, Hong Kong, Singapore and ADGM, setting up our custody operations steadfastly. 

What’s To Look Out For In 2024

We are excited to announce that our commitment to integrating the most secure digital asset wallets with a cutting-edge custody platform is swiftly becoming a reality. 

The upcoming year, 2024, will serve as a testament to this transformative journey. Moving beyond self-custody, we are constructing a comprehensive infrastructure encompassing both custodial and non-custodial wallets. Exciting products are set to launch starting from the first week of January, some of which are: 

  • Official Custody Platform Launch
  • Liminal’s Off-Exchange Settlement Hub
  • Secure Custody of Real-World ‘Tokenised’ Asset

The Web3 space has evolved explicitly this year, pushing the narrative of secure digital asset custody and security, introducing new regulations and compliance standards, licensing VASP providers and standardising the use of custodians as a trusted third party. 

At Liminal, we took major strides this year, from building comprehensive products to becoming a regulated custodian, from revamping our brand design to building the full infrastructure of custodial and non-custodial wallets.

January 5, 2024

Find Out How You Can Benefit From A Fully Self-Custodial Wallet Architecture