As the fiat-driven financial world devolves into increasingly opaque and inflationary falsehood, governments, banks, and corporations alike continue to get away with using more money than they have available to them. What was once a 1:1 gold-backed dollar is now an unbacked, fractionally-reserved digit on a computer screen, subject to the fickle whims of humans inherently driven by self interest.
The world is in need of a newly restored sense of trust in institutions – but how is that done with a foundation built on infinitely-printable money?
It isn’t.
What companies across all industries need to implement is a Proof of Reserves system, backed and verified by bitcoin: the only immutable asset on the planet.
What Is Proof Of Reserves?
Proof of Reserves (PoR) is a cryptographic auditing process that allows financial institutions to demonstrate that they hold sufficient assets to back customer deposits. So if I had 30 bitcoin (unwisely) custodied by my bank, I could have greater confidence in the bank to keep the bitcoin secured if I could verify that it was in fact being held and not being loaned out or used for anything else.
Proof of Reserves provides that transparency that our current financial institutions lack.
Be honest: Can you confidently tell me where exactly the money in your bank account lies today? Can you know, without a shadow of doubt, that your money is and will always be available for withdrawal from the bank in case of emergency, and that it won’t be wound up in lending products being used by other institutions around the world?
One of the key breakthroughs in understanding bitcoin is understanding that for the first time since digitizing our money, we can know exactly where our money is. It’s not floating around somewhere in the ether of a central bank database. You can take self custody and keep it wherever you want it to be.
Companies apply this breakthrough to their financial services through Proof of Reserves, ensuring to their clients that they have the money ready and available, and that any movement of this money is well documented and provable through the Bitcoin ledger. For honest-acting companies, there would be no incentive to move that money whatsoever, making it easy for potential customers to verify which institutions truly keep the customers’ needs first.
Don’t Forget Proof Of Liabilities
Proof of Reserves is essentially “Proof of Assets”. But as any good accountant would tell you, along with disclosing assets, you also need to disclose liabilities. Otherwise, how can we be sure that the assets a company acquires aren’t coming from irresponsible or downright fraudulent fiscal activity?
Proof of Assets and Proof of Liabilities thus need to coexist alongside one another to get a full picture of a company’s true financial status.
Proving liabilities isn’t as straightforward as proving assets. Unlike with assets, where, in the case of bitcoin, you can simply point to the company’s Bitcoin address, giving users public access to the real-time holdings, as well as former and future movements of those funds, liabilities are more private in nature. Custodians may not be able to legally disclose who they owe bitcoin to, so in order to prove what they owe without revealing to whom it belongs, companies can use a Merkle-Sum tree.
The top of the tree represents the total liabilities held by a given company or custodian. Each branch of the tree represents the individual entities and what they are owed. The given example only uses four accounts, however you can imagine a larger company having hundreds or thousands of clients. The Merkle-Sum tree demonstrates the holdings of each individual client totalling the equivalent amount of liabilities a company holds. By matching this number to the number of assets, we get the company’s reserve ratio. Ideally, a fully reserved company should have a 100% reserve ratio, meaning they have 100% of assets available to cover liabilities. If, however, a company’s Proof of Reserves showed that they only held 4 BTC for every 10 BTC they have in liabilities, that means they only have 40% of assets available to cover liabilities. Not so ideal.
When you take this concept and apply it to the legacy banking system, which managed to operate on a mere 10% reserve ratio – and even lower today – you can see how the dangers of a fractional reserve system become a lot more apparent.
How Proof Of Reserves Differs From Traditional Banking
Today we operate on a fractional reserve banking system. Prior to 2019, banks with more than $124.2 million were required to keep 10% of customer deposits on hand, while being able to loan out the rest. For banks between $16.3 million and $124.2 million, they needed a mere 3% reserve ratio. This practice works on the assumption that not all customers will demand to withdraw their money at the same time. However, as history has demonstrated through fallouts like Mt. Gox, or FTX, when there’s no money left to dish out, the people who didn’t act quick enough to withdraw are left penniless. The cryptocurrency space runs rife with stories like these, however, the real-world banking system suffers from the same fate.
What’s very concerning to understand now is that following the 2020 pandemic, the Federal Reserve dropped the reserve ratio requirements to literally 0%. Banks simply do not need to have your money on hand for you any longer. Put another way: The central banking system is drunk at the wheel with fractional reserves, and has no plans to park the car until it crashes.
The logical evolution of our reckless banking infrastructure involves radical change: a Proof of Reserve standard. An institution operating under PoR is required to hold 100% of customer deposits in reserve. Otherwise, the customer may not be able to build trust in the institution for not doing so, and may instead opt to store their money with a competitor.
Unlike fractional reserve banking, which inherently erodes trust without allowing the people to do anything about it, bitcoin enables the financial world to restore trust through positive-sum incentives. By establishing verifiable transparency at the forefront of every customer interaction, financial institutions now have an incentive to earn customers through trust retention rather than blind faith. The free market inherently creates a much more virtuous competitive landscape for people to decide where their money belongs.
The world today doesn’t play by these rules, but as bitcoin continues to grow, as companies continue to adopt PoR, and fiat financial institutions continue to break trust in the people, the tide is shifting faster every day towards a market that demands Proof of Reserves upfront.
Who Is Carrying The Torch Today?
It’s crucial to understand that “Proof of Reserve companies” are analogous to “internet companies”. Today, we don’t call any companies “internet companies”. They are just called “companies”. The internet became a de facto standard for every business that wanted to successfully operate in the modern world. In the same light, “Proof of Reserve companies” will hopefully just be called “companies” in the future, as the global market demands PoR upfront in order to be viable for business.
To get there, a select few companies are spearheading the movement.
- River is a US-based Bitcoin financial services company known for its emphasis on transparency and security. You can verify the company’s Proof of Reserves here.
- MicroStrategy, a publicly traded business intelligence company, is another entity carrying the torch of transparency. MicroStrategy made a name for itself by spearheading corporate adoption of bitcoin. In August 2021, CEO Michael Saylor announced that the company converted 100% of its cash reserves to bitcoin in order to stop the inflationary bleed of holding fiat currency. Today, the company is running arguably the most innovative business playbook of the 21st century, issuing convertible debt of its own inflationary shares in order to stack cold hard, deflationary bitcoin. You can verify MicroStrategy holdings here.
- Metaplanet is a Japanese financial firm that followed in Microstrategy’s footsteps. You can verify the holding of Metaplanet here.
Along with these companies, Hoseki provides a free dashboard for viewing the balances of Bitcoin custodians, enabling you to verify their holdings and not simply trust what they say. Most major exchanges also implement PoR, however, one of the largest in the space – the only publicly-traded one – is still slacking.
Coinbase’s Proof Of Reserves – Or Lack Thereof
As River points out, if we don’t normalize Proof of Reserves, we are inevitably going to be left with paper bitcoin.
The largest exchange in the US, Coinbase, recently came under fire following the announcement of its wrapped Bitcoin product, cbBTC. Without Proof of Reserve to verifiably show that they have the BTC on hand to support backing an Ethereum-native altcoin masquerading as BTC, investors worried that Coinbase is tapping into their customer deposits or otherwise inflating their real Bitcoin holdings. This concern escalated even further when BlackRock, the world’s largest asset manager, whose Bitcoin Spot ETF Coinbase is the custodian of, directly responded to the rumors by mandating a 12-hour withdrawal requirement from Coinbase.
Coinbase’s CEO tried to use his words to settle the uncertainty, however, those mere words unsurprisingly stirred up greater distrust.
If Coinbase wanted to address these concerns and settle the uncertainty, implementing a Proof of Reserves standard would not only accomplish that, but as the largest publicly-traded company in the “crypto” space, it would also set the precedent for other companies looking to go public. “Why would I keep my bitcoin with XYZ-smaller company if Coinbase is proving their reserves and has much greater backing behind it?”
Proof of Reserves is not only a trust-building mechanism, but also a competitive angle for companies to leverage.
Why Companies Need Proof Of Reserves
If a society is built on false premises, how can one expect anything to work?
If 2 + 2 ever stops equalling 4, then we have a serious problem. Nothing that we use mathematics for to construct would function properly. Everything would collapse. Buildings would crumble. Education would crumble. Then society crumbles.
If we’re operating under the premise that banks can spend more than what’s actually available to them, we inevitably create a world in which we don’t have the resources to support the “abundance” we’ve created. As the Cantillon effect demonstrates, the value instead flows up to the top 1% who are closest to spending, at the expense of the bottom 99%.
That is the reality we live in today. While it allows an advantage for financial institutions in the short term, in the long term it’s destructive to the civilians who rely on these institutions, and inevitably creates distrust that leads to the destruction of those institutions as well.
History is a non-stop loop of civilizations building themselves up and tearing themselves down. Humanity hasn’t been able to support a civilization that lasts longer than a few hundred years. The false premise that’s baked into our monetary system – that a currency needs inflation (i.e. value debasement) over time – makes it impossible to reliably sustain any economic progress that we make in the short term.
Rather than working with a human-led system that’s inherently biased to our own greed and selfish interests, bitcoin, for the first time in history, sets the world up for a sustainable long-term future. By having an immutable, verifiable ledger that’s immune to human intervention, people, companies, governments, and nations alike can opt into a system that instills trust from the very foundation. Proof of Reserves is one manifestation of how a trustful society operates. No longer do the people accept guesswork when it comes to our own money – our energy – and how it’s allocated. A Proof of Reserve standard is a verifiably true statement directly from institutions that we don’t have to trust them at all. We can see for ourselves whether a company is financially ethical or not.
Final Thoughts
Proof of Reserves sets the stage for a major shift in today’s financial landscape. Fiat-driven incentives have allowed large institutions to take advantage of public trust, without verification, but PoR flips the script so that before we trust, we verify.
For truly ethical companies, Proof of Reserves is an obvious improvement to their playbook, but for dishonest companies, they will likely do whatever they can to avoid it themselves. The mere existence of Proof of Reserves is a major step forward for the public, as it helps us to better identify who’s really here to support the people, and who is here to take advantage of us.
As pioneers like River set a new standard for transparency, we can expect to see more and more companies adopt a similar strategy to stay competitive in the evolving financial space. Yet again, bitcoin is proving its world-changing value to the world by checkmating the bad actors who’ve kept their lies hidden for years, decades, and centuries. It’s certain that governments who notoriously spend what they don’t have will not welcome this change, but as long as Proof of Reserves continue to grow among our institutions, the noise will only get louder and more difficult for them to drown out.
Beyond the tangible change to company structures, Proof of Reserves represents an intangible shift in society towards an emphasis on trustworthiness, integrity, and honesty. I’d bet any amount of money that a civilization built on these principles will outlast any that clings to the skewed incentives of fiat, and you should too. Buy bitcoin today and become a part of the movement towards Proof of Reserves.
Thank You
If you found this article helpful, please consider sharing it on social media. You can also help us out with any of the following.
- Follow us on Twitter and Nostr.
- Support one of these Bitcoin businesses.
- Make a value for value donation so that we can continue to publish more Bitcoin-only content.
Any support we get from bitcoiners is what keeps this project alive.