Full Reserve Banking

A Full Reserve Banking or 100% reserve banking system is one in which banks must hold reserves for 100% of on-demand liabilities. This means that should on-demand creditors all simultaneously ask for repayment, the bank will be able to honour all its obligations. This contrasts with a system of Fractional Reserve Banking.

Term-deposits and other time liabilities are not limited by a full reserve banking policy. However the bank should plan to have enough reserves when their term expires and these debts become enforceable. "The date on which the bank's obligations fall due must not precede the date on which its corresponding claims can be realized. Only thus can the danger of insolvency be avoided." (Ludwig von Mises. The Theory of Money and Credit. 1912).

Proof of Reserves

In the Bitcoin world, inasmuch as exchanges have acted like banks by holding user Bitcoin balances, we have seen instances of Fractional Reserve Banking practices and also bank-runs leading to insolvency. Most notably in the case of Mt. Gox. Since then Bitcoin exchanges and other companies acting as Bitcoin custodians have started to offer cryptographic Proof of Reserves, Multisignature vaults, third party audits and other ways for users to verify that the company's Bitcoin liabilities in the event of insolvency do not exceed reserves.

Vaultoro, Kraken, BitStamp, Xapo or Uphold are some of the companies that pioneered Proof of Reserves levels of transparency.

2022

After the FTX crash of November 2022 several other large exchanges have announced that they will implement Proof of Reserves audits, including Binance, OKX, ByBit, Crypto.com, KuCoin, Bitfinex, Huobi... Coinmarketcap has even started indicating which exchanges provide exchange reserve data.

Criticism of Proof of Reserves

Critics have pointed out that audits can be gamed and falsified. Coins can be moved shortly before or after an audit. Data can be falsified. Auditors can be corrupted (as was the case with Enron).

Nevertheless defenders of proof of reserves have countered that it becomes much harder to falsify audits as the level of transparency increases. Real-time on-chain audits give the earliest, fastest and most visible warning signs of insolvency. Cryptographic verification tools open to individual users are harder to fake than quarterly audits by third parties.

Not your keys, not your Bitcoin

Critics counter that however sophisticated or fast a proof of reserves audit is, it is never as good a security system as individual Bitcoin custody. Withdrawing your bitcoins from exchanges is the only certain way to completely avoid counterparty risk. Leaving coins on centralized exchanges only for the minimum time necessary to buy/sell is the only real way to minimise risk.

DEX

Decentralised exchanges like Bisq claim to allow Bitcoin trading while allowing users to keep control of their bitcoin during the entire process. Since the exchange never holds any keys, it is impossible for it to lose or steal user funds.