Does proof of reserve guarantee transparency?
A look at the proposed solution.
As the contagion of the FTX implosion continues to impact both the markets and more stakeholders in the space, other large players could be impacted in the near future.
Will customers leave CEXs and go DeFi or will they even leave crypto for good?
One thing is clear, in order to bring trust back to the crypto industry, more transparency is needed.
ANALYSIS OF WHAT HAS BEEN DONE SO FAR
The recent releases of Proof of Reserves data by a handful of CEXs on their platform is definitely a good first step towards that goal, however there are still many additional ways to increase transparency and trust.
Many of these solutions don’t seem to be on-chain, which raises the issue of potential off chain alterations to the data. Additionally, anything done off chain requires some type of third party verification, like an audit.
Writing it on the blockchain, instead, would enhance security.
PROOF OF RESERVES VS PROOF OF SOLVENCY
Many of the Proof of Reserves solutions offered today only show the current balances of user wallets. Only the assets side of the equation is revealed. This is an incomplete picture of the overall solvency of an entity. Liabilities and fiat reserves would be needed to complete the picture and show the financial health and trustworthiness of these companies.
The PoS or Proof of Solvency could solve some of these issues.
Proof of solvency = Proof of Reserves — Proof of Liabilities
Exposing all the data and their sources can raise concerns in terms of privacy and security.
The use of zero-knowledge proofs like ZK SNARKs, as suggested by Ethereum’s Vitalik Buterin in a recent blog post, could be an option to ensure data safety.
Through a mathematical function, ZK can hide the data used in a Merkle tree. The result of the solvency equation which is written on chain with the root hash is then visible without knowing all the input. This preserves privacy about a CEX’ treasury and liabilities but still proves their solvency.
Furthermore ZK proofs make it possible for a customer to remain anonymous when verifying their balance on chain.
Proof of Reserve is certainly an improvement over the lack of any solution today. A centralized exchange can at least show that they have enough assets to support the deposits that have been made. Nevertheless, we still need to improve that solution towards proof of solvency in order to provide a more complete picture that takes into account both the assets as well as the liabilities. This is the real challenge and the most difficult to achieve.
As stated in our previous post, Merkle Trees are ideal for storing large amounts of data, specifically wallets and balances in this case. Having such a system in place improves accountability and transparency.
But there are even more advantages to using the blockchain for improved security.
A Merkle tree root hash anchored on the blockchain becomes immutable. This data would be publicly available, verifiable on-chain, and cannot be altered.
Having this data verified by a network of independent nodes can further enhance security and accuracy.
Umbrella Network’s architecture already has a functioning technology that can do just that.
Join us in our effort to explore this proof of solvency concept. A collaboration with other projects, CEX and partners is key in order to move towards a more transparent and trusted future for the blockchain and crypto community.
About Umbrella Network
Umbrella Network is a scalable, decentralized, and community-owned oracle that utilizes Layer 2 technology to integrate real-time data into smart contracts that is secure, scalable and cost effective. Umbrella Network brings the world’s data to the blockchain to enable applications to perform at the optimum level regarding precise information dissemination. We believe a decentralized oracle is paramount to creating a truly decentralized blockchain ecosystem.
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