Proof of Solvency is the outcome of merging two other proofs—Proof of Reserves and Proof of Liabilities. This dependable way makes sure that the valuable things a place has are more than what they owe to others.

Proof of Reserves (also known as Proof of Assets): is about demonstrating that the assets customers store in a cryptocurrency exchange or financial institution are the same as the assets the business keeps in reserve. This helps ensure customers’ interests are safe.

Proof of Liabilities is a method to provide transparency on the total amount of user deposits in the custodian, proving the total quantity of coins the exchange owes to all of its customers.

Using an analogy with lemonade to better explain this;

Proof of Reserves: Imagine you’re running a lemonade stand. You keep track of how many lemons, sugar, and cups you have. You also keep track of how much lemonade you’ve already sold. This is like a “proof of reserves” for your stand. It shows that you have enough ingredients to cover the lemonade you’ve promised to customers.

Proof of Liabilities: Now, let’s say you’ve promised to give your friend a glass of lemonade when they visit your stand later. This promise is a “liability.” It’s something you owe to someone. You make a note of this, just like a company would note down the things it owes to others, like loans or debts.

What is proof of solvency?

So, when we talk about “proof of solvency,” we mean the process of checking that a business has more than enough assets to cover what it owes to others. It’s like making sure you have enough lemonade ingredients to serve all your thirsty customers and friends. This helps customers trust the business because they know it can keep its promises and give them their money back when needed.

Why proof of solvency ?

The most significant evidence of a custodian’s financial stability that it can offer to its clients lies in the assurance that your money will be available whenever you need it. It’s like the most crucial way a money keeper can show they’re in good financial shape to their customers, ensuring you can be sure your money is ready for you anytime you need it.

Why is proof of solvency important?

A solvency certificate, a significant document provided by a bank or another financial institution, serves as official confirmation that the individual or company in question is financially stable. This certificate assures that they possess the necessary resources and financial strength to successfully repay any debts they might have.

What’s the limitation of Proof of Solvency?

While the proof of solvency is a valuable measure, it doesn’t consider a company’s capacity to secure additional sources of funding over the long term, like investments from stocks or bonds. Because of this, just like with the solvency ratio, the proof of solvency should also be used together with other forms of analysis to offer a complete picture of a business’s financial stability. Ratio analysis can offer some insights into a company’s long-term sustainability by assessing profitability, solvency, and efficiency.

Key points

• Proof of Solvency is the outcome of merging two other proofs—Proof of Reserves and Proof of Liabilities
• Being aware that a financial institution is solvent provides you, as a customer, with the assurance that your money is available whenever you need to use it.
• Proof of Solvency acts as a formal statement that the person or company is financially secure.
• Proof of Solvency doesn’t think about whether a company can get more money from sources like stocks or bonds in the future.