With the debacle of the cryptocurrency exchange FTX, insolvent despite its status as the third largest exchange in the world, the issue of proof of reserve for all platforms is back on the table. Explanations.
The fall of the American FTX empire recorded in November is only the replica of the examples of Mt. Gox, the exchange founded by the French Mark Karpelès, and the Canadian platform QuadrigaCX, which fell in 2014 and 2019 respectively, due to mismanagement and the use of fractional reserves. A method that consists of operating without keeping all customer deposits in reserve is very risky in the context of the undeniably volatile cryptocurrency market.
What is the proof of reservations?
Proof of reservations is an initiative that aims to increase the transparency of digital resource providers and ensure the correct presence of resources at a given address. Already in 2014 and with the bankruptcy of Mt. Gox, American columnist and tax expert Jason Tyra published on the concept of “Proof-of-reserve”, the need to require cryptocurrency platforms to meet this transparency standard. In 2019, bitcoin start-up Blockstream offers a technical methodology to popularize the practice. But it is above all the analyst Nic Carter who returns to social media and the press on the subject at regular intervals to spread the concept to the main interested parties: users.
It is necessary to differentiate the proof of reservations from the audit. An audit is a procedure performed by an entity to assess the compliance of a company’s accounts. But while a cryptocurrency exchange platform can be solvent or have a consistent balance sheet, that doesn’t stop it from using an individual’s deposit for a purpose for which the individual has not given their consent. The two procedures are therefore compatible: the audit to verify the solvency of a company, the proof of reserves, the correct use of user deposits.
How to perform a reserve test?
Proof of reserves should therefore allow each user of the platform to personally verify the presence of their assets at the deposit address, as if a bank customer came to verify the presence of an asset in his trunk.
For this it is necessary to compare the data produced by the platforms with the information contained in the blockchain, the only reliable source. There are several methods: encryption with the Merkle tree (a hash structure containing encoded data), the footprint of which must be compared with the readings of the platform; build a (non-finalized) transaction containing all unspent bitcoins (UTXO) of a platform; the simple production of a list of reserves associated with public keys and to be compared with customer balances and addresses.
Which platforms produce proof of booking?
The US platform Gate.io is one of the first to implement a stock test tool, using the Merkle tree technique, followed by its counterpart Kraken. After the FTX scandal, Binance, OKEX, Kucoin promised to use the same process.
Bitmex once used the same process, but now publishes a simple downloadable file to allow the customer to compare the on-chain assets with the data published by the platform. As for the Blockstream process of the invalidated UTXO transaction, it is used by the Bitcoin Core and Trezor wallets.
And in France, then?
In France, the StackinSat platform did not wait for the FTX disaster: since last June it has announced the launch of its proof of reserve system. For this, use the services of a service provider, Israeli Fireblocks. On the side of the Coinhouse and Paymium platforms, the procedures are not yet in place but according to our information they are each in the work phase on the subject.
We remind you that to operate on our soil the PSAN status, issued by the AMF, is mandatory and requires an annual audit, even if this does not constitute, as we have seen, proof of reservations.