Adam Back led Blockstream has come up with a new standardized solution for exchanges to prove whether they possess the funds that they claim to have.
Over the years many Cryptocurrency exchanges have duped users into believing that they have enough funds to back up their claims while successfully running fractional reserve lending on exchanges which has even led to solvency issues.
Only a few exchanges take the effort to prove their balances, usually, they deploy an in-house solution to generate their proofs which makes it difficult for regular users to verify. To solve this problem Blockstream has come up with a methodology initially built for the company’s Bitcoin sidechain implementation Liquid.
How Does this work?
Traditionally exchanges would have to prove their reserves via a third-party auditor or move all the funds to a new set of addresses which is deemed risky. With Blockstream’s solution, the exchange would be able to prove their Bitcoin reserves without having to move it.
“Proof of Reserves allows an exchange to prove how many bitcoin they could spend, without needing to generate a “live” transaction or exposing themselves to the risks of moving funds.”
Using Blockstream’s tool the exchange has to spend all of the Bitcoin UTXO’s and add an extra invalid input, the entire transaction will be rejected by the network due to the invalid input. But the transaction is constructed in a way that allows one to verify all of the exchange’s spendable UTXO’s. Hence exchanges will be able to share the transaction data with anyone who wants to verify.
Blockstream also plans to add privacy features that would make it easier for exchanges and even exchange users to use the product and verify funds.
Find the project on Github.
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