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Proving reserves is becoming more effective, but not all of the challenges are technical

Delbert Williams IIBy No Comments4 Mins Read

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Proof of Reserves (PoR) has gone from buzzword to buzz in recent weeks as the crypto world tries to recover from the shocks and losses of the current crypto winter. After a series of discussions and work, appropriate PoR criteria and rankings are beginning to emerge, but the finer points of how proof of reserve should be done or who should do it remain an open question. remains.

The differences between proof of assets and proof of reserves, along with their own flaws, were quickly pointed out. Attempts by traditional auditors to provide a PoR were quickly frustrated, and major companies quickly withdrew.

Doug Schwenk, CEO of Digital Asset Research (DAR), told Cointelegraph that auditors may never provide the assurances users seek for PoR. Audits are done regularly, but cryptocurrencies he trades around the clock.

DAR provides information and underwriting services to traditional financial giants and produces the FTSE Russell indices in partnership with the London Stock Exchange. “We would like to see proof of the reservation. […] It’s not enough to say I’m happy, but it’s better than nothing. ‘ he added:

“In the world we currently navigate, sometimes being better than nothing is a good starting point.”

To further complicate matters, centralized (CeFi) and decentralized (DeFi) platforms present fundamentally different challenges. Thanks to its transparency, the “sign of reservation deserves to be called” [itself] According to Amit Chaurhary, Head of DeFi Research at Polygon, a scalable blockchain ecosystem compatible with Ethereum,

Related: Proof of Reserve: Can a Reserve Audit Avoid Another FTX-Like Moment?

Chaudhary told Cointelegraph that the zero-knowledge Ethereum virtual machine (zkEVM) the company is developing will bring “well-tested security” to PoR. The software uses Merkle trees to check both positive (asset) and negative (liability) balances, allowing users to verify their accounts while maintaining a high level of privacy. Additionally, the Zero Knowledge Protocol can provide double collateral management for safer payments and anti-money laundering and know-your-customer control while maintaining anonymity.

The immutable nature of blockchain records enables verification of audit processes. Chowdhary added:

“You can deploy an accounting system on zkEVM. You can design your own accounting system.”

CeFi has a much bigger challenge. “Because debt can occur off-chain, there is no way to demonstrate proof of debt, allowing businesses to honor all customer deposits,” said Matthew Aleph, founder of Aleph Zero Blockchain. Niemorg told Cointelegraph in a statement.

Centralized cryptocurrency exchanges take various measures to provide PoRs that meet the needs of users. Exchange OKX, which recently committed to delivering new PoRs monthly, uses PoRs and Nansen dashboards based on the open-source Merkle Tree protocol. Nansen provides real-time third-party transaction tracking.

OKX told Cointelegraph that the exchange uses a Merkle tree to validate holdings of the top three assets: BTC, ETH and USDT. OKX Assets and Liabilities.

“OKX discloses wallet addresses via the Nansen dashboard,” further explained OKX. This will allow users to check their OKX holdings in real-time to “verify that there is sufficient reserves on-chain for users to withdraw”.

Despite OKX’s and other exchanges’ efforts to be transparent, “no matter how much math or cryptography you do, even if the book is audited by a respected independent third party.” “But nothing can solve the human problem of deception and fraud. Garbage in, garbage out!” said Niemorg.

One of the challenges of providing transparent services is cultural. Traditional finance “has the advantage of living in 2022, where highly regulated capital markets have been around for almost 100 years,” Schwenk said.

The DAR aims to “apply the same rigor as regulators” to “the kinds of companies accustomed to placing high levels of trust in their counterparties.” Nevertheless, “today it is impossible to have complete information on any of these counterparties, because many of them are still working out some maturity issues, and the traditional Because we have a hard time being nervous like we see in finance,” Schwenk said.