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Proof of reserves is becoming more effective, but not all its challenges are technical

December 31, 2022No Comments


Proof of Reserves (PoR) has gone from buzzword to roar in recent weeks as the crypto world tries to recover from the shock and losses of the current crypto winter. After a flurry of discussion and work, the criteria and classifications for a proper ByR are starting to appearbut the fine points of how to test reservationsor even who should do it remain open questions.

The difference between asset testing and reserve testing was promptly pointed out, along with their shortcomings by themselves. Attempts by traditional auditors to provide PoR were soon thwartedwith major companies rising and falling rapidly.

Auditors may never provide the assurance that users seek from PoR, Doug Schwenk, CEO of Digital Asset Research (DAR), told Cointelegraph. Audits are done periodically, while crypto transactions are 24 hours a day. "Ideally, you would have a way to measure those liabilities and assets in some kind of real time," he said.

DAR provides information and vetting services to leading companies in traditional finance and produces the FTSE Russell index in conjunction with the London Stock Exchange. โ€œWe like to see reserve tests. [โ€ฆ] It's not enough to say we're satisfied, but it's certainly better than nothing." He added:

"In the world we're navigating in right now, better than nothing is sometimes a good starting point."

To further complicate matters, centralized (CeFi) and decentralized (DeFi) platforms present radically different challenges. Thanks to its transparency, "the reserve test is worthy of being called [itself] proof of reserveโ€ in DeFi, according to Amit Chaurhary, head of DeFi research for Polygon, an Ethereum-compatible scalable blockchain ecosystem.

Related: Proof of reserves: Can reserve audits prevent another FTX-like moment?

Chaudhary told Cointelegraph that the Zero Knowledge Ethereum Virtual Machine (zkEVM) being developed by the company brings "battle-tested security" to PoR. that program use Merkle trees to see balances both positive (assets) and negative (passive) balances and allows a user to verify their accounts while maintaining a high level of privacy. In addition, zero-knowledge protocols can offer dual collateral control for more secure settlement and anti-money laundering and Know Your Customer controls while preserving anonymity.

The immutable nature of the blockchain record would allow verification of the audit process. Chaudhary added:

โ€œYou can implement an accounting system on your zkEVM. You can design your own accounting system.โ€

CeFi presents much bigger challenges. โ€œSince liabilities can be incurred off-chain, there is no method for showing proof of liabilities and for a business to honor all customer deposits,โ€ Aleph Zero blockchain founder Matthew told Cointelegraph. Niemerg, in a statement.

Centralized cryptocurrency exchanges are taking a variety of steps to provide PoR that meets the needs of users. OKX exchange, which has recently made a commitment to provide PoR updated monthly, uses PoR based on an open source Merkle tree protocol along with a Nansen dashboard. Nansen provides real-time third-party transaction tracking.

OKX told Cointelegraph in a statement that the exchange verifies its holdings of its top three assets, BTC, ETH, and USDT, using a Merkle tree, which allows users to verify their holdings, verify that their balance is included in total liabilities. of the bag and compare. OKX assets and liabilities.

โ€œOKX discloses its wallet addresses through the Nansen control panel,โ€ OKX further explained. This allows users to check OKX holdings in real time "to make sure OKX has enough reserves on-chain for users to withdraw."

Despite the efforts of OKX and other exchanges to provide transparency, โ€œno amount of math or cryptography can solve the human problem of deception and fraud, even if the books are audited by respected and independent third parties. Garbage in, garbage out!" Niemerg said.

Part of the challenge of providing transparent services is cultural. Traditional finance has the "benefit of living in 2022, where we have almost 100 years of highly regulated capital markets," Schwenk said.

The DAR seeks to "apply the same rigors as regulators" to "the type of companies that are used to having a high degree of trust in their counterparty." However, "it's impossible to get perfect information on any of these counterparties today, because many of them are still getting through some maturity questions and are struggling to be as buttoned-down as you see in traditional finance," Schwenk said.