Bitcoin exchange hacks and security failures are notorious. While users who hold their digital assets in cold wallets are not generally affected, anyone using a hot wallet on an exchange puts their funds at risk of a hack, theft, or downright mismanagement.
Blockstream, founded by Adam Back, has suggested a simple but elegant way for Bitcoin exchanges to prove the existence of their reserves. Called the ‘Proof of Reserves Tool,’ the solution allows all exchanges to ‘display’ their reserve Bitcoin assets without actually spending them.
A Solution at Last
The solution is already being hailed as a much-needed step in bringing cryptocurrency to the world. Bitcoin is designed to increase trust in personal finance, but with failures such as the Zaif hack of $60 million and the current QuadrigaCX debacle, trust among consumers is actually declining rapidly.
The Blockstream solution is elegant because it allows an exchange to prove its reserves without spending them. Simply put, the Proof of Reserves Tool does not require a ‘live’ transaction or any movement of funds.
Instead, the exchange creates a transaction which spends all its Bitcoin UTXOs but includes a single invalid input. The invalid input renders the entire transaction invalid but proves that the exchange still possesses all the Bitcoin it claims to have in its reserves. The data is then easily shared with those needing to verify the data.
No-fear Audits and Transparency
With the proof of reserves in hand, auditors will now be able to provide clarity regarding whether a cryptocurrency exchange is actually solvent. Unlike the failed solutions by QuadrigaCX and Cryptopia, the Proof of Reserves Tool provides genuine trust for consumers. Those exchanges which are doing business properly will have no reason to fear producing verification of funds, while consumers can be protected from those that are unable.
Additionally, Blockstream is continuing to develop the Tool in order to allow exchanges to publicly verify their assets without compromising too much data. This would allow exchanges to effectively be in a state of ‘constant proof’—a further step toward trust and transparency.
Blockstream for Adoption
With one of the main arguments against cryptocurrency adoption being the lack of transparency, the Proof of Reserves Tool goes a long way in providing that much-needed component. This is in line with the business model of Blockstream, which has sought to provide global Bitcoin node access via satellite.
The company’s release early this year of the FIBRE upgrade has already provided a simple and secure way to relay blocks on the Bitcoin network without time delays. This feature effectively makes Bitcoin available to everyone, all the time, without barriers.
Taken together, the upgrades and the new transparency tool provide effective solutions to both problems facing Bitcoin adoption—accessibility and transparency. Blockstream is clearly taking the practical steps needed to achieve Nakamoto’s dream.
Do you think the new Proof of Reserves Tool will be used by exchanges? Will it fall by the wayside? Let us know your thoughts in the comments below!