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The renowned blockchain programmer wrote a blog on how centralized exchanges can move toward trustlessness.
Buterin opines zero-knowledge succinct non-interactive argument or knowledge (ZK-SNARK) is the best proof of the reserves.
Ethereum’s co-founder Vitalik Buterin published a blog on November 19, 2022, on how CEXs (centralized exchanges) can use cryptographic proofs to assure the public that the funds held on-chain cover what they owe.
Buterin wrote that on top of the measures used in TradFi (traditional finance) such as auditors, corporate governance, licensing and due diligence at minimum, CEXs could add a system restricting them from withdrawing users’ funds without their consent.
Citing a discussion that started nine years ago, the blog explained,
“If you prove customer deposit equal X (proof of liabilities), proof of ownership of private keys of X coins (proof assets), then you have the proof of solvency.”
The discussion by the Russian-born Canadian programmer comes a week after the implosion of derivatives exchange FTX termed by its new CEO, John Ray, as a “complete failure of corporate controls.”
The blog post which acknowledged input from Coinbase, Kraken and Binance noted that such significant blow-ups could be avoided using cryptographic proofs like the balance sheet technique, Merkle Tree, ZK-SNARK, Plasma and Validiums.
ZK-SNARK touted the best technique for factoring in privacy
Buterin believes that ZK-SNARK is the best of all the models comparing it to transformers (machine learning models) in artificial intelligence since it proves that the total balance is not negative. He described the technology as complementary to the Merkle Tree.
How it works
Users deposit funds into the Merkle tree or KZG commitment that allows the prover to compute commitment to a polynomial. The system would then show the value of the polynomial at a particular position as the claimed value.
With the hashing for privacy, the Merkle branch or KZG proof allotted to each user conceals individual balances. The system also works for lenders by allowing users to put a record onto a Merkel tree or polynomial of the loan amount.
The root of the Merkle is published on-chain, and the system can then identify overleveraged borrowers.
Plasma, Validums and the future of non-custody
The renowned programmer also discussed Plasma and Validiums techniques s a way to prevent CEXs from stealing users’ funds. Validiums are an improvement of Plasma.
In the smart contract, “each coin is assigned an index and lives in a particular position in the Merkle tree of a plasma block.”
In addition, making a valid coin transfer requires putting a transaction into the correct position of a tree and publishing the root on-chain.
Vitalik foresees a future of custodial consisting of centralized exchanges controlled by smart contracts like Validiums and non-custodial exchanges leaning toward non-custody. There could also emerge half-custodial exchanges with fiat and cryptocurrency, says the programmer.
Jared Kirui is an experienced financial writer with a passion for all things blockchain technology. Previously, he was into stock markets and forex, providing asset managers with top-notch content. With a flair for producing high-quality articles, he started covering crypto news in 2021. He is open-minded, trades for fun, and enjoys sports.
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