Binance Proof of Reserves

Introduction:

As the popularity of cryptocurrency continues to grow, so does the need for secure and trustworthy cryptocurrency exchanges. Binance, one of the largest cryptocurrency exchanges in the world, has taken steps to address this need by implementing a unique security feature called Proof of Reserves (PoR). In this article, we’ll explore what Binance PoR is, how it works, and why it’s an essential component of Binance’s overall security strategy. By the end of this article, you’ll have a deeper understanding of the importance of PoR in ensuring the security and trustworthiness of cryptocurrency exchanges like Binance.

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Proof of Reserves (PoR) Explained

A PoR audit is one that aims to ensure that custodians are holding their clients’ funds in full. Custodial businesses in cryptocurrency use PoR audits to prove to depositors and the public that their deposits match their balances. These audits are conducted by independent third parties to eliminate the possibility of reserve data being falsified.

PoR is essential for several reasons. Firstly, it enables users to verify that the balances they hold on a cryptocurrency exchange, for instance, have absolute asset backing. Secondly, it drives businesses to meet transparency standards, making it difficult for them to engage in questionable or illegal financial activity.

Ideally, PoR should benefit both users and businesses. It protects users by minimizing security risks and safeguarding against harmful players. At the same time, it helps businesses retain users by increasing their trustworthiness.

What does PoR verification do?

In PoR verification, an auditor verifies the inclusion of each account’s balance using cryptography. The auditor takes a snapshot of all account balances and converts the fund data to a Merkle tree, which structures large amounts of data for more straightforward processing. User balance data is hashed into a “leaf,” which is then hashed with other leaves to form a “branch,” and a group of “branches” are hashed to form the “root.”

The auditor can use various methods to verify ownership of the user address. For example, on Binance, the auditor has three ways to identify ownership: cryptographic message signing, instructed movement of funds, and searching addresses on a blockchain explorer. If the balances match these forms of discovery, the Binance exchange has verified PoR and shown that it holds all deposited assets in totality.

Ways to Identify Ownership

Cryptographic Message Signing: An auditor will provide the exchange with a unique message to cryptographically sign using their associated private key(s). This ensures that the exchange is the rightful owner of the funds being audited and that the funds are not coming from a third party.

Instructed Movement of Funds: Here, the exchange is tasked with performing a specific movement of funds where the management will move a specific amount from a public key/address at a specific time and obtain the transactional hash to verify the instructed transaction on the respective blockchain. This process ensures that the exchange has the necessary funds to back up user balances.

Search Addresses on a Blockchain Explorer: The final method is to search the ETH and BSC (in the case of Binance) address(es) on Etherscan and BscScan, respectively, to ensure that the addresses have been tagged as belonging to the exchange. This step confirms that the exchange owns the funds claimed to be in reserve and that they are not the funds of another party.

Merkle Tree in PoR Verification

As mentioned earlier, the auditor converts user account data into a Merkle tree to structure large amounts of data for more straightforward processing. But what exactly is a Merkle tree, and how does it work?

A Merkle tree is a type of binary tree data structure that is used in cryptography to efficiently and securely verify the integrity of large datasets. It is named after its inventor, Ralph Merkle.

In a Merkle tree, each leaf node represents a piece of data (in this case, a user account balance), and each non-leaf node represents the hash of its child nodes. The root of the tree is the hash of the entire dataset. This allows the auditor to efficiently verify the authenticity of individual pieces of data by only having to verify a small number of hash values.

For example, if an auditor wants to verify the authenticity of a particular user’s account balance, they only need to verify the hash of the user’s leaf node, along with the hashes of its parent nodes, up to the root of the tree. This makes it much faster and more efficient than having to verify the authenticity of every single data point in the dataset individually.

By using a Merkle tree in PoR verification, the auditor can ensure the integrity of the user account data without having to rely on trust in the exchange’s own reporting. It also provides an efficient and secure way to structure and verify large amounts of data.

zk-SNARKs

Binance uses a zero-knowledge proof protocol called zk-SNARK to provide an additional layer of security and transparency to its PoR. By using a zk-SNARK, Binance can prove that all Merkle tree leaf nodes’ balance sets (i.e., user account balances) contribute to the exchange’s claimed total user asset balance.

Each user can easily access their leaf node as having been included in the process. For each user’s balance set (Merkle tree leaf node), the circuit ensures that a user’s asset balances are included in the calculation of the sum of the total net user balances with Binance, the total net balance of the user is greater than or equal to zero, and the change of Merkle tree root is valid (i.e., not using falsified information) after updating a user’s information to the leaf node hash.

What is a zk-SNARK?

A zk-SNARK (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge) is a proof protocol that follows the zero-knowledge principles previously outlined. With a zk-SNARK, you can prove that you know the original hashed value without revealing what that value is. You can also prove the validity of a transaction without revealing any information about the specific amounts, values, or addresses involved.

How it works

To verify their own transactions, Binance users can log in to the Binance website, click on “Wallet,” and then click on “Verification.” The user will be able to find their Merkle Leaf and Record ID within the page. They can select the verification date they want to check and find confirmation of the verification type, their Record ID (specific to their account and this particular verification), the assets that were covered, and their asset balances at the time of the verification.

The Record ID/Merkle Leaf enables users to independently verify that their account balance was included by the third-party auditor.

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Importance of Proof of Reserves (PoR) for Exchange Users

Proof of Reserves (PoR) is an essential security measure for crypto exchanges as it provides several benefits for their users, including:

Protection of user funds: PoR verifies that an exchange holds all of the deposited assets in totality, which helps to prevent any fraudulent activities or potential insolvency. With PoR, users can trust that the exchange is holding their assets securely.

Increased transparency and trust: PoR offers a more transparent way to audit the financial market, which is essential during financial turbulence. By using mathematics and cryptography, exchanges can demonstrate that they are following best practices and ensure the integrity of their operations. This can help to build trust between the exchange and its users.

Comparison with other security measures: While there are other security measures available to exchanges, such as cold storage and multi-factor authentication, PoR offers a unique advantage. PoR provides a way to verify that an exchange has all the assets it claims to hold, which is critical for user protection. Other security measures can help to prevent unauthorized access to accounts or data breaches, but they don’t provide the same level of assurance as PoR.

Check out: Proof of Reserves (PoR) Explained

In summary, PoR is an essential security measure for crypto exchanges as it helps to protect user funds, increase transparency and trust, and provides a unique advantage compared to other security measures. By using PoR, exchanges can demonstrate their commitment to best practices and ensure the integrity of their operations.

Final Takeaway

In conclusion, Proof of Reserves (PoR) is an essential security feature implemented by Binance to ensure the trustworthiness and security of its cryptocurrency exchange. PoR enables users to verify that their balances on the exchange have absolute asset backing while also driving businesses to meet transparency standards and eliminate the possibility of reserve data being falsified. By using a Merkle tree in PoR verification and a zero-knowledge proof protocol called zk-SNARK, Binance provides an efficient and secure way to structure and verify large amounts of data while ensuring the authenticity of individual pieces of data. Overall, PoR is a crucial component of Binance’s security strategy, and its implementation can serve as a model for other cryptocurrency exchanges to follow.