Exchange Proofs of Reserves & Solvency: a mechanical explanation

Not your keys, not your coins is a common aphorism in the cryptocurrency world. Because cryptocurrencies are bearer assets, users who store funds with a custodian lose out on seizure-resistance and self-sovereignty, two of the key benefits of cryptocurrency. The history of the space is littered with exchanges who have lost user funds to hacks, fraud, and human error, and users who leave their funds on an exchange are ultimately trusting that entity not to lose their money.

Still, the presence of centralized custodians is likely unavoidable. A significant amount of work has been put toward developing alternative solutions, but while distributed exchanges such as Bisq allow users to exchange assets without storing their funds with a centralized party, centralized exchanges offer a level of convenience and liquidity that is difficult to compete with in a non-custodial system. Self-custody is difficult, and centralized custodians offer a way for users to gain exposure to cryptocurrency with limited technical expertise.