Crypto Pills

By: Eloisa Marchesoni
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  • Your weekly dose of crypto craze
    Copyright Eloisa Marchesoni
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  • EP. 1 What is Proof of Reserve revision

    EP. 1 What is Proof of Reserve revision
    Nov 22 2022
    The world of crypto is still unregulated; after the first crashes in the 10s, it was thought that states would sooner or later begin to intervene proactively. Well, we are now in the middle of the third decade of this century and nothing has yet changed: with few exceptions, exchanges continue to manage huge funds without anyone being accountable to them, least of all investors, who largely continue to choose the most profitable ones, no matter how murky the management.Since 2011, more than 50 exchanges collapsed, for a wide variety of reasons: let’s look at the most significant crashes.Mt. GoxEstablished in July 2010 and named by Jed McCaleb after the popular card game “Magic the Gathering”, this exchange was sold to the French developer Mark Karpelès, and relocated to Tokyo.As with the pioneers of all industries, many problems plagued this exchange from the beginning, starting with the 2609 BTC burned to the wrong address, through the 25000 BTC stolen from 500 accounts.The end came on February 7, 2014, when, after months of delays, withdrawals were finally suspended: there was a shortage of 744 thousand Bitcoins embezzled by Karpelès.QuadrigaCXThis is my favorite: In December 2018, upon the death of founder Gerald Cotten, the Canadian exchange declared that it was no longer able to access the cold wallets where customers’ funds were vaulted.It became apparent early on that five out of six had already been emptied by months anyway, and that the exchange was run by Cotten like a Ponzi scheme.FTXIt took four days from the discovery of an $8 billion hole to the total collapse of the FTX exchange and its currency.Tokens were being printed out of thin air, coming and going from a subsidiary company named Alameda Research.Sam Bankman-Fried, the CEO, has a split attitude, somewhere between contrite, belligerent and feel-good.It is still too early to tell how things will end: the risk of a ripple effect like the one caused by Lehman Brothers in 2008 remains, however.Proof of ReservesA Proof of Reserves (PoR), is an independent audit to ensure that exchanges are properly managing customer assets.The auditor captures an anonymous snapshot of all balances held and aggregates them within a Merkle tree, a data structure that encapsulates all customer balances.From there, the auditor obtains a Merkle root, a cryptographic fingerprint that uniquely identifies the combination of these balances at the time the snapshot was created.The auditor then collects the digital signatures produced by the exchange, which demonstrate ownership of the on-chain addresses with publicly verifiable balances.Finally, the auditor compares and verifies that these balances exceed or match the customer balances represented in the Merkle tree, and thus that the customers’ assets are held in full-reserve mode (i.e., that there is always collateral available to the customer, and have not instead been lent or reinvested).Any client can independently verify that their balance has been included in the Proof of Reserves audit by comparing selected data with the Merkle root. Any changes made to the data, no matter how small, will affect the root, making the tampering obvious.Who has already done it (Kraken)Semi-annual audits have been conducted by Armanino LLP (one of the top 25 largest accounting, consulting and technology firms in the U.S.), following the specifics given by the American Institute for Certified Public Accountants. Kraken provides Armanino only anonymized balance information, meaning no sensitive client data is exchanged.Who is going to do it (Binance)Changpeng Zhao said that in a short time his exchange will also be Proof of Reserves compliantIn the meantime, he published a list of the top 6 held assets:475K BTC 4.8M ETH 17.6B USDT 21.7B BUSD 601M USDC 58M BNBspecifying that it was data already published previously, though not so easily available.Who has proven how not to do itKris Marszalek, CEO of Crypto.com also showed a “preview” of his Proof of Reserves but… quotation marks are appropriate since they have more Shiba Inu than Ethereum: what the heck?!?NexoNice neat little drawing: probably my 5-year-old nephew could have done better: would someone kindly get some more information?Joking aside (not so much…) the Nexo people, with the complicity of Armanino LLP, have come up with Real Time Proof of Reserve, where no less than a Nexo proprietary API, communicates data from customers deposits, and then compares them with Nexo’s assets, again picked up via API.Now you tell me the difference between this mechanics and someone who constantly says “we are solvent.”What is incredible is that a serious company like Armanino would indulge in this.ChainlinkBut what is “proof”?We generally think of proof as verifying a statement to be true, but you can also prove something to be false. And what happens if an organization doesn’t provide proof? Customers and counterparties have no way to verify if the ...
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    9 mins

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