Kraken founder and former CEO Jesse Powell says he is looking to publicly flag problems in the crypto space, starting with the issue of exchanges sharing their proof of reserves.
Following the high-profile crash of FTX, crypto exchanges have scrambled to provide evidence of a one-to-one ratio between investor reserves and assets in an effort to increase transparency.
According to Powell, a reserve test audit is valid if comes from with proof of customer balances and wallet control.
“I said that I was going to be more assertive in pointing out the problems. This is one of them.
‘Reserves’ = assets minus liabilities. ‘Reserves’ = list of wallets…
The reserves audit trail must have:
1. sum of client liabilities (auditor should exclude negative balances)
2. User-verifiable cryptographic proof that each account was included in the sum
3. signatures showing that the custodian has control of the portfolios.”
The Kraken founder highlights that using Merkle Tree to allow users to verify the cryptocurrencies they hold on an exchange is pointless, as it does not reveal the responsibilities of the centralized platform.
Merkle Trees are data structures that can allow users to quickly check certain information without displaying an entire data set.
He says Powell,
“The Merkle Tree is just a manual operation without an auditor to make sure you didn’t include accounts with negative balances. The statement of assets is meaningless without liabilities.
This is simply, ‘Here’s a hash of your record in the BTC spreadsheet.’ Ok… but what’s the point? The point of this is to understand if 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 He suggested a system where users can check their personal balances on crypto exchanges through Merkle Trees.
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