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 reserves for all platforms is back on the table. Explanations.
The fall of the American FTX empire recorded in November is only a replica of the examples of Mt. Gox, the exchange founded by the Frenchman Mark Karpelès, and the Canadian platform QuadrigaCX, which fell respectively in 2014 and 2019, due to mismanagement and the use of fractional reserves. A method of trading without holding all client deposits in reserve is oh so risky in the context of the undeniable volatility of the cryptocurrency market.
What is the reserve test?
Backup Proof is an initiative that aims to increase the transparency of digital asset providers and ensure the correct presence of assets at a given address. Back in 2014 and after the bankruptcy of Mt. Gox, US columnist and tax expert Jason Tyra published on the concept of “Proof-of-reserves”, the need to require cryptocurrency platforms to meet this standard of transparency. 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 propagate the concept to the main stakeholders: users.
It is necessary to differentiate proof of reservations from audit. An audit is a procedure performed by an entity to evaluate the compliance of a company’s accounts. But while a cryptocurrency trading platform may be creditworthy or have a sizeable balance sheet, that doesn’t stop it from using an individual’s deposit for a purpose to which that individual has not consented. 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 reserve should therefore allow each user of the platform to personally verify the presence of his assets at the deposit address, as if a bank customer were 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 on the blockchain, the only reliable source. There are several methods: encryption with the Merkle tree (a hash structure containing encoded data), the fingerprint of which must be compared to platform reads; build an (unfinalized) 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 bookings?
The US platform Gate.io is one of the first to implement a reserve testing tool, using the Merkle tree technique, followed by its counterpart Kraken. Since the FTX scandal, Binance, OKEX extension, Kucoin promised to use the same process.
Bitmex once used the same process but now publishes a simple downloadable file for the customer to compare assets on chain 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, it uses the services of a service provider, the Israeli Fireblocks. On the side of the Coinhouse and Paymium platforms, the procedures are not yet in place but according to our information, both are in the process of working on this topic.
We remind you that to operate on our soil the PSAN status, issued by the MFA, is mandatory and requires an annual audit, even if this does not constitute, as we have seen, proof of reservations.