111% reserves can still fall short
Crypto exchanges often publish proofs of reserves claiming, for example, 111% reserves against customer assets. Showing that public addresses really hold the assets is meaningful. But the figure does not mean the exchange can pay all its debts.
This guide separates what a proof of reserves proves from what it does not. It calculates in a hypothetical table how solvency looks different depending on which liabilities are included, and explains the scope of Merkle-tree balance checks and what to look for in reports.
What the asset side shows
The asset side usually consists of a list of blockchain addresses the exchange controls and signed proof of that control. Anyone can check those balances on chain, so the fact that the assets existed at a given moment is strongly demonstrated.
Blockchain balances alone cannot show whether the assets belong to the exchange, were borrowed briefly, or are already pledged as collateral. Assets borrowed just before the snapshot and returned afterward are hard to distinguish from on-chain records alone.
The liability side and Merkle trees
Vitalik Buterin's essay on proof of solvency describes combining customer balances in a Merkle tree, publishing the total, and letting each customer verify that their balance is included. That makes it harder for an exchange to quietly shrink customer balances to understate liabilities.
A Merkle tree covers only customer balances. Loans from other institutions, debts to affiliates, and off-balance-sheet arrangements are not in it. And whether some customers' balances were left out is revealed only if those customers check.
A hypothetical solvency calculation
The table assumes an exchange holding 100 in public wallets that proves customer balances of 90 through a Merkle tree. It also owes 30 to another creditor, and 20 of its wallet assets are pledged as collateral for that loan.
| Calculation | Assets | Liabilities | Ratio | Reading |
|---|---|---|---|---|
| As published in the proof of reserves | 100 | Customer balances 90 | 111% | Looks sufficient |
| Including other borrowing of 30 | 100 | 90 + 30 = 120 | 83% | Short |
| Excluding 20 pledged, customers only | 80 | 90 | 89% | Short even for customers |
The same exchange reaches different conclusions depending on what assets and liabilities are counted. The figures illustrate what to check.
Snapshots and timing
A proof of reserves is usually a snapshot at one moment. It matters whether assets and liabilities were measured at the same time and whether that moment was announced in advance. A known snapshot date makes it easy to fill wallets for that day, and different measurement times leave out changes in between.
Shorter intervals between proofs, unannounced snapshot dates, and published balance histories for reserve addresses all add credibility. A consistent series of proofs says more than a single announcement.
It is also worth noticing what happens around market stress. If an exchange publishes proofs regularly in calm periods but pauses them when withdrawals surge, the gap itself is information.
Reading the reports
Work through these steps with any proof-of-reserves or third-party review report. Internal control reports such as AICPA's SOC reports can assess custody procedures but do not by themselves prove solvency.
- Check whether the report covers only customer balances or all of the exchange's liabilities.
- See whether reserve addresses and proof of control are published, and whether the report addresses pledged or encumbered assets.
- Confirm that assets and liabilities were measured at the same time and whether the snapshot date was announced in advance.
- Use the exchange's tool to verify that your own balance is included in the Merkle tree.
- Note who performed the review, which procedures were done, and whether the report is an audit or an agreed-upon-procedures engagement.
Proving both sides together
Buterin's essay also describes using zero-knowledge proofs to show that liabilities add up correctly and contain no negative balances without revealing individual accounts. That strengthens the customer-balance side, but the limit on off-book liabilities remains.
Judging overall solvency still requires traditional information alongside on-chain proofs: financial statements, loan agreements, and dealings with affiliates. For listed companies, financial filings can be found in systems such as EDGAR, where borrowing and related-party disclosures sit in the notes.
Limits of the proof
The assets, liabilities, and ratios here are hypothetical and illustrate what to check. Real exchanges' proofs differ widely in method, scope, and review procedures.
When checking, read the exchange's latest report and the reviewer's explanation with their dates. This guide does not recommend using any exchange or trading any asset.