Kraken founder and former chief executive Jesse Powell says he’s looking to publicly point out problems in the crypto space, starting with the issue of exchanges sharing their proof of reserves.
Following the high-profile collapse of FTX, crypto exchanges have been scrambling to provide evidence of a one-to-one ratio of reserves to investors’ assets in an effort to increase transparency.
According to Powell, a proof-of-reserve audit is valid if it comes with proof of client balances and wallet control.
“I said I was going to be more assertive with calling out problems. This is one of them.
‘Reserves’ = assets minus liabilities. ‘Reserves’ = list of wallets…
Proof of reserves audit must have:
1. sum of client liabilities (auditor must exclude negative balances)
2. user-verifiable cryptographic proof that each account was included in the sum
3. signatures proving that the custodian has control of the wallets.”
The Kraken founder highlights that using a Merkle Tree to allow users to verify the crypto they own on an exchange is “pointless” as it does not reveal the centralized platform’s liabilities.
Merkle Trees are data structures that can enable users to quickly verify certain information without showing an entire data set.
Says Powell,
“The Merkle Tree is just hand wavey bu**s**t without an auditor to make sure you didn’t include accounts with negative balances. The statement of assets is pointless without liabilities.
This is simply, ‘Here’s a hash of your record in the BTC spreadsheet.’ Ok… but what’s the point? The whole point of this is to understand whether an exchange has more crypto in its custody than it owes to clients. Putting a hash on a row ID is worthless without everything else.”
Earlier this month, Ethereum (ETH) creator Vitalik Buterin suggested a system where users can verify their personal balances on crypto exchanges through Merkle Trees.
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