Premise: proving that you are solvent using cryptographic means
Answer: let's re-invent accounting.
Look the problem is this, as an "exchange", to be profitable you either need to charge fees, or do some sort of fractional reserve, using deposited value as capital for your Exchange's investments.
If you go for option one, then you will be undercut by someone doing option two. The tradeoff being, number two is more likely to loose all your customer's cash.
The value of something is more often than not irrational. This means that there is subjectivity in the value of assets. You can't technology your way out of that. This means that its perfectly possible to prove that you have liquid assets that will cover your present position. However thats expensive to maintain. So you start buying longer term more illiquid assets (think property, commodities, companies, etc) some of these are liquid in a day, others months.
Worse still the value of them depends on how and when you sell them.
So sure you can have assets that cover all your liabilities one day, then due to a re-valuation, not have enough.
Thats not the same as solvent though.
But, all of this neatly misses the point of crypto. If its a practical payment system, rather than an investment, you wouldn't hold your crypto at an exchange. You hold it your self and move it when you need to convert/liquidate.
Looking for a cryptographic solution to this is certainly missing the point - it presupposes cryptocurrency coins and tokens are assets in the traditional sense, which they are not. At best they are like casino tokens - they have no intrinsic value, no legal entitlement to anything, and their use is entirely at the discretion of the issuing casino. That works fine for casinos because everything operates within the casino. The problem is that cryptocurrency wants to go outside the cryptocurrency sphere and into the real world, which is something that it is simply not designed to do. As we have seen, this leads to endless exploits, e.g. VCs and exchanges printing up billions of dollars worth of tokens, claiming they are actual assets (imagine a real casino printing chips with a total face value of $1.6 billion and claiming they had $1.6 billion in assets), convincing retail "investors" to exchange real money for those "assets", and then using that real money to gamble in different casinos.
It's solving a simple and well-defined problem: making sure that whatever tokens you put in the exchange, you can get back out. You may think this is beside the point, but it's exactly what FTX miserably failed to do.
It's not reinventing accounting. It's making sure that the accounting you do is public because that allows for trust.
I think it would be cool if we, as a society, had easy API access to everything our governments spend their money on. Wouldn't you say that would be for the greater good?
Making something public doesn't solve the problem. Deceiving the public is easy and the public is duped frequently. Making accounting public doesn't solve the problem at all.
Budgets and financial statements for US federal and municipal governments already have to be public. If you're talking about the bill of materials and receipts for every individual transaction, there are some pretty serious obstacles to that. At minimum:
- The government directly provides medical service via the VA and DoD and disclosing every transaction risks HIPAA violations.
- It may not now be illegal, but I think there would be some privacy concerns about things like revealing every person's student loan payments.
- Counseling and employee assistance type stuff for government employees can't be made public for the same reasons.
- Criminal fines for anyone whose record is later expunged present a hurdle.
- Payments to confidential informants in criminal investigations obviously need to stay confidential or you're going to get them murdered.
- Witness protection payments same thing.
- At least some transactions are classified.
- Contract details are kept hidden from other contractors right now to avoid undercutting and collusion.
All in all, as long as you're forced into some system where maybe some, even most, transactions can be made on a public ledger, but others have to be kept private, you'll never prevent fraud and/or suspicions of fraud in the form of transactions being kept illegally private. At some point, you have to trust the auditors and Congressional oversight committees.
> I think it would be cool if we, as a society, had easy API access to everything our governments spend their money on. Wouldn't you say that would be for the greater good?
We can't do that, because then people would realize it's all a house of cards. In an unrelated note, when was the last time US gold reserves were audited?
Note, there could be option 3 whereas its fractional but a gov-owned central bank entity.
Where pure crypto exchanges get into problems with fractional reserves is loaning out, etc. via their own invented tokens. Why? Because then they are setting up themselves as Central Bank with their own Reserve without the power of printing money and other gov things to counter Bank runs.
FTX could have done less than stellar legal trading of FTT in bull market and would have still blown up as evidenced by some of the firms it acquired.
We are still at the original economic problem when a crypto exchange sets it self up as Federal Reserve
Yeah exactly, fractional reserve does not work without a well developed inter banking network provided by a central bank. That just means that fractional reserve banking is inherently instable and requires periodic bailouts.
It did? The whole collapse was kicked off by someone looking at the books and raising an alarm.
If you’re instead asking why financial audits paid for by FTX didn’t publicize the company’s solvency issues, well, we’ll all find out during the upcoming bankruptcy proceedings.
Presumably there would be value for users in knowing that their deposits are covered. Therefore, users who perceive value in this way would be willing to pay a premium.
There's also the possibility of exchange insiders trading against user's on-platform stop losses to profit.
>So sure you can have assets that cover all your liabilities one day, then due to a re-valuation, not have enough.
I understood this as a proposal to verify customers could withdraw their deposited coins. If they have traded into another asset, then they would still be able to withdraw. Not sure what you meant here?
>But, all of this neatly misses the point of crypto. If its a practical payment system, rather than an investment, you wouldn't hold your crypto at an exchange. You hold it yourself and move it when you need to convert/liquidate.
Agree about the speculative nature.
It would still create more trust for traders or frequent users of an exchange. Keeping coins off-exchange eliminates the risk entirely. However if users expect to trade on a CEX, they would still have to expose themselves to that risk for the duration of their trade.
>> Presumably there would be value for users in knowing that their deposits are covered. Therefore, users who perceive value in this way would be willing to pay a premium.
Like banks which have to ensure, where I live up to 100k €, customer deposits?
Every problem, issue with crypto-tech seems to be solved with yet another layer of crypto-tech. Every criticism of the tech is deflected by pointing at yet another project that is claimed to fix what is being criticized.
Humans have been solving the problems of existing technology with more technology for quite a while now. This comment is like criticizing database indexes as a mere technical band-aid over the fundamental problem of having too much data.
The problem is that databases solve a real world problem: businesses and people need to store data, and the database is literally the solution for that.
Cryptocurrencies have so far not resulted in a compelling use case. All that we are seeing is a questionable solution looking to solve some as yet undiscovered problem.
The parent comment is a bit flippant, but I agree with the thought. The entire crypto industry is rapidly becoming a bizarre and convoluted rube goldberg machine that is completely impenetrable to anyone but the most ardent zealots. Even more, as an outsider it seems like everyone is in this echo chamber of back patting and "with just this one more buzzword bingo sounding feature, we'll have unlocked the true potential of crypto".
That's what building out a new ecosystem looks like. Not every single person in the world needs to spend their building CRUD REST APIs and doing GAAP accounting.
Not ever person in the world needs to work on trying to totally reinvent things either. But the idea that something is wrong because it's different than what already exists is ridiculous. It's literally Larry David looking at the wheel in the commercial and saying "seems pointless".
I admit, I did not read that in detail. Can someone explain how the "proof of liabilities" is proving that it contains all liabilites of an exchange? for example the electricity bill that is coming to be paid next week or the off-book loan of x billion cryptocoin from your fellow exchange that you need to pay back also next week?
Awfully lot of trust you seem to need in this fancy world of trustless money of the future.
If you close your eyes and ears, then it is possible to imagine that such filthy thing as offchain liabilities doesn't exist. At least when Kraken posts about their "proof of liabilities" without actual audit of offline liabilities on Reddit r/cc, they readily eat that claim, no one challenges it. And then in every single post about this new trend, they will write that Kraken is somehow solvent due to this. I guess this was the point - if people already believe in something, it doesn't need to be real :) .
I don't think it solves that at all, but, as I understand it, that's not been the problem _so far_. If someone has lent an exchange assets against its users' assets then it's not at all clear that they have the superior claim to those assets if the exchange goes bankrupt can't repay those liabilities.
> If someone has lent an exchange assets against its users' assets then it's not at all clear that they have the superior claim to those assets if the exchange goes bankrupt can't repay those liabilities.
Right, but if an exchange took out a bank loan, the loan was recalled, and the exchange repaid it with customers' deposited cash and later goes bankrupt - possession is nine-tenths of the law.
Especially if the exchange intentionally has a structure that can avoid international tax laws - who's to say it won't also avoid international bankruptcy laws?
Other creditors may or may not have preferential claims over depositors. The point is that you can't prove that the exchange is solvent (which was the entire point of this exercise) unless all assets and liabilities are considered.
All benefits of cryptocurrencies goes out the window when you introduce centralized exchanges. "trustless" is referring to the protocols, not the ecosystems.
It's not necessarily about covering all liabilities of an enterprise nor all its assets. It's about building a proof that you hold your customer assets and you are not running a fractional reserve. You may still run an unprofitable business and perhaps at some point you go bankrupt. But at least all the customer assets are there and segregated from the business assets and you cannot use them as the piggy bank for your business.
So, lets imagine you have been running this continuously from the beginning and there is absolutely nothing fishy on the chain of the events of the ledger that makes this proof. All customer deposits (1B worth of coins) are backed by respective assets (1B) in the portfolio. Unfortunately the business has been run badly, and in addition to this portfolio, the exchange has assets of one worthless laptop, but there are some tax liabilities worth 2B and an just found loan payable to Italian Mafia worth also 2B. Tax authorities file for bankruptcy.
1. How does the exchange ensure money is paid to the customers instead of Mafia or tax authorities?
2. If/when it can't, how these liabilities are included in the proof of liabilities?
(note: this is a real and difficult problem. That's why there are laws, regulations and deposit insurances around customer funds in finance, which, yes, fail occasionally. I just do not see how that can be solved by blockchain.)
> But at least all the customer assets are there and segregated from the business assets and you cannot use them as the piggy bank for your business.
Why would they be segregated? The priority of creditors in a bankruptcy proceeding is controlled by courts that will order assets handed over to senior creditors whether they are holding "on chain" liabilities or not. It is the disclosure of such a contract that is the problem of understanding all liabilities, both on and off chain, as bankruptcy court doesn't care about the distinction.
The idea is that the exchange publishes a sum of their liabilities, and each individual user can check that their balance was uniquely included in the sum, cryptographically.
Unfortunately this does not prove in any way that the exchange has included all liabilities in the sum, it only proves your deposit is included. A very, very different thing.
"Proof of reserves" including Vitalik's heath robinson crypto schemes, provide minimal assurance to exchange users. Why?
It's what one would call a "limited assurance engagement" in audit parlance. In other words, it provides assurance over a small subset of the balance sheet of an exchange - only the customer deposits and the exchange liabilities pertaining to said customers.
However, there are a few red flags which no-one seems to raise:
1) The customer deposits should be off balance sheet if they actually were held in custody. If deposits are not off balance sheet then customer assets cannot be held in custody. Instead, the customers are a creditor of the exchange.
2) From the terms and conditions I've read for various exchanges, customers are typically not treated as a preferential creditor.
3) In the event of an insolvency, customers are treated pari passu with other creditors.
4) To get sufficient assurance that the exchanges can honour their customer liabilities, we need to see ALL of the liabilities, not just the subset relating only to customer deposits. E.g. Who else is money owned to? Did they issue debt? Did they borrow from a bank? Are there any legal provisions? Etc...
5) Given the legal treatment of customers as unsecured creditors, without entire visibility of the balance sheet, the "proof of reserves" report is pretty much useless.
4) ... this is why tradfi ringfences. One legal entity for the deposits one legal entity for the business. The entity for the deposits has only liabilities to customers + assets from customers.
In fact, on (2) this isn't even something an exchange can do through their Ts&Cs. Local law will decide creditor priority so in the absence of a regulatory framework that treats exchanges as "bank-like" and makes, as a minimum, customer balances "special" in some way, this simply isn't possible.
It's easy to be dismissive of everything crypto-related after the FTX crash, but we should remember that the problem of fraudulent business practices isn't specific to crypto at all.
It's yet to be seen whether proof-of-holdings is practicable for crypto assets, let alone for real world assets. But it is an interesting use case for zero knowledge protocols that could tackle some very real problems. Yes, we have auditors in the real world, and I'm not thinking of replacing them, but it could improve audits. As one example, not too long ago there was a crash of a German payments provider of a scale not much smaller than FTX (Wirecard) that was audited by one of the major firms (EY), who missed a fake $2bn bank deposit claim.
And IMO, more than the scale, it's the immature bragging of being totally better than the old stuff. That said this aspect is not only in crypto, it's in the era.. lots of internet thingies are touted that way, your bluetooth connected balance that is not accurate and will fail in 6 monthes.
Sure, that was not the point of my post. It seems that most people have reacted to this half-sentence, I think the technical discussion would have been far more interesting for this forum, especially when it comes to applications outside of blockchains. I could list more examples where substantial losses to real clients (of "normal" businesses) could have been avoided if there was a better way of proving simple facts like bank balances to auditors (it's in fact partly related to my work).
The current process basically looks like this: an auditor will ask the bank to confirm that client X has such and such balance with them. Of course, the bank needs to be sure that the auditor is actually who they claim they are, so they get in touch with their client to confirm that they can tell the auditor their balance. Since this is a bit tricky if the auditor doesn't have a direct line of communication with the bank already, it is often facilitated by the client directly asking the bank to issue a balance confirmation to the auditor, and that's an entry point for impersonation attacks (in an overly simplified manner, that's also what happened at Wirecard). We probably don't need the exact fancy machinery of Merkle sum trees and zero knowledge proofs outlined in the OP, we also don't want to bring in blockchains, but I was wondering whether we could use some of those ideas to make the audit process for normal firms a bit safer.
I hate to no-true scotsman you, but if you kept significant amounts of cryptoasset in a centralised exchange, you weren't living in the desert, you were living in a sandbox.
> the problem of fraudulent business practices isn't specific to crypto at all.
The problem with crypto is that the bulk of the value is created through seigniorage of the tokens required to make it work, not actual utility derived from its technical features, for example better privacy or enabling new transactions.
So in reality the pump & dump, rugpull and speculative bubble dynamics are characteristic to crypto because there is very limited actual wealth created and a massive conflict of interest from the players to cash in on the juice flowing though their systems, which are nothing else than unregulated and inferior copycats of existing financial institutions, state issued currencies, banks etc.
Many of us were dismissive of everything cryptorelated even when many others became millionaires or billionaires believing into it. If you needed something as pathetic as the FTX fiasco to change your mind, you’re right, that’s unreasonable for sure.
> many others became millionaires or billionaires believing into it
Yeah, being first in a Ponzi scheme tend to work well for some people. For every winner in cryptocurrency there are losers as cryptocurrencies are a zero-sum game.
And Wirecard was a clear fraud. They didn't steal customers deposits so. And, all in all, Wirecards accounting was lightyears better than FTXs, Wirecard held bank liscenses which requires proper book keeping of assets and deposits.
I think the speed and low-fees required in (some types of) financial trading just can't happen fully on chain. So that's another reason for centralization in exchanges
Also it's interesting to note that in regular finance, exchanges and brokerage firms are separate entities .. meanwhile eg FTX was both the exchange and the 'broker'
Edit: just searched twitter and came across someone asking SBF this exact question about the conflict of interest in being both the exchange and broker (of course he was also trading with client funds on top of that..)
> I think the speed and low-fees required in (some types of) financial trading just can't happen fully on chain. So that's another reason for centralization in exchanges
That's currently being resolved with the implementation & adoption of rollups: There're currently multiple efforts towards developing zk-based rollups, with everyone (Polygon, zkSync, Scroll) taking a different approach towards providing it. Right now, optimistic rollups are the dominant rollup strategy right now, with improvements & decentralization already undergoing development & deployment.
Most still have guardrails in place, but it's publicly known & already being worked on.
> I think the speed and low-fees required in (some types of) financial trading just can't happen fully on chain. So that's another reason for centralization in exchanges
You could have an exchange whose users have 2nd-layer channels open to it for all the currencies they trade.
Trading can then happen near-instantly with 0 fees.
While still centralized, it doesn't need to take custody of any user's funds.
So what I really don't get about the decentralized fans: They repeatedly say, our goal is to replace entities like DEX.
But replace with what? With people like Vitalik? He seems to be an influential figure and calling the shots. How is this in any way different than a "normal" company with a CEO and a board.
We already have functional, audited, open source DEXes and have had them for years now.
Uniswap was the first well-done AMM (automated market maker) design. It's on version 3 now, and has traded more than $1.2 trillion in volume: https://uniswap.org/
FTX was primarily used for perpetuals trading, which is a type of leveraged derivative product. Popular decentralized perp products include:
GMX: https://gmx.io/#/
and Dydx: https://dydx.exchange/
Vitalik is certainly influential, and he did conceive of and invent the first smart contract blockchain, but he doesn't call the shots any more than Tim Berners-Lee controls the web.
I love uniswap as a concept. Whatever my reservations are about crypto, there are some projects I think are good, uniswap being one of them. Staying true to the decentralized aspects and all that. What I dont understand is, if we have uniswap, why are there other exchanges coming in and establishing a big market. Is it a UX thing? Or is the crypto ecosystem addicted to leveraged trading? If I was a crypto person I would definitely be in favor of more uniswap and less coinbase and binance.
Ideally, open-sourced & audited smart contracts that are ERC-compliant & developed by the general public, with the internal mechanisms made viewable to anyone that wants to learn how such mechanisms work.
> With people like Vitalik? He seems to be an influential figure and calling the shots.
Vitalik can point at where focus could be targeted at, but the decision is ultimately up to the developers themselves. In fact, as far as I can remember, most of the efforts mentioned in the post & image below are not publicly mentioned at all, with other developers leading the charge on that front. (Danksharding being one example, with the development efforts led by Dankrad Feist, hence the name.)
> How is this in any way different than a "normal" company with a CEO and a board?
The main difference is that development is not wholly left to one party: Anyone can choose to develop the applications that they want to see & deploy them onto the platform. Even if you're external from the main development efforts, you can still contribute to the overall ecosystem with code contributions towards one of the various nodes of the entire system. This stands in contrast with a standard company, where external development's forbidden outside of a special area designated for the general public to interact with.
The curtains are slowly getting pulled aside for the "crypto" ecosystem. Tokens on tokens on centralized or non-scaling systems that generate "yield" without really specifying where the yield comes from. Vitalik is indeed a CEO or CTO for the Ethereum Foundation, which in itself is a cetralized entity calling the shots for the development path, including changes to the emission of ETH.
I fully expect that system to come crashing down in 5-10 year.
Vitalik isn’t running any DEXes, he is not in a position where he can steal or move user funds locked into a DeFi contract. He could suggest a change that might do something malicious at protocol level, but the rest of the developer community would reject it.
CEO of a bank can't do that too. The board can though. And of course customers can reject that decision and switch bank. But in reality that won't happen both in the bank case and in the tokenbro case. We have already saw how Vitalik stole lawful tokens from the receiver of The DAO program (code is law after all), and everyone has supported him. Exactly the same as banks can do, only without outlandish claims.
This is so funny. Self-styled geniuses inventing infinitely iterable levels of complexity to invent infinite levels of why they should have infinite governance around the concept of digital money is probably the best grift in generations.
Don’t get me wrong, I think it’s great. In the US, it’s mostly the worst folks actually losing to this game and I’m overall entertained.
edit: I should maybe clarify that my crypto holdings are now about $20, entirely from folks losing bets to me.
Readit News
Answer: let's re-invent accounting.
Look the problem is this, as an "exchange", to be profitable you either need to charge fees, or do some sort of fractional reserve, using deposited value as capital for your Exchange's investments.
If you go for option one, then you will be undercut by someone doing option two. The tradeoff being, number two is more likely to loose all your customer's cash.
The value of something is more often than not irrational. This means that there is subjectivity in the value of assets. You can't technology your way out of that. This means that its perfectly possible to prove that you have liquid assets that will cover your present position. However thats expensive to maintain. So you start buying longer term more illiquid assets (think property, commodities, companies, etc) some of these are liquid in a day, others months.
Worse still the value of them depends on how and when you sell them.
So sure you can have assets that cover all your liabilities one day, then due to a re-valuation, not have enough.
Thats not the same as solvent though.
But, all of this neatly misses the point of crypto. If its a practical payment system, rather than an investment, you wouldn't hold your crypto at an exchange. You hold it your self and move it when you need to convert/liquidate.
There is no such thing beyond food, water and shelter.
I think it would be cool if we, as a society, had easy API access to everything our governments spend their money on. Wouldn't you say that would be for the greater good?
That's exactly what Vitalik is proposing.
- The government directly provides medical service via the VA and DoD and disclosing every transaction risks HIPAA violations.
- It may not now be illegal, but I think there would be some privacy concerns about things like revealing every person's student loan payments.
- Counseling and employee assistance type stuff for government employees can't be made public for the same reasons.
- Criminal fines for anyone whose record is later expunged present a hurdle.
- Payments to confidential informants in criminal investigations obviously need to stay confidential or you're going to get them murdered.
- Witness protection payments same thing.
- At least some transactions are classified.
- Contract details are kept hidden from other contractors right now to avoid undercutting and collusion.
All in all, as long as you're forced into some system where maybe some, even most, transactions can be made on a public ledger, but others have to be kept private, you'll never prevent fraud and/or suspicions of fraud in the form of transactions being kept illegally private. At some point, you have to trust the auditors and Congressional oversight committees.
Where pure crypto exchanges get into problems with fractional reserves is loaning out, etc. via their own invented tokens. Why? Because then they are setting up themselves as Central Bank with their own Reserve without the power of printing money and other gov things to counter Bank runs.
FTX could have done less than stellar legal trading of FTT in bull market and would have still blown up as evidenced by some of the firms it acquired.
We are still at the original economic problem when a crypto exchange sets it self up as Federal Reserve
If you’re instead asking why financial audits paid for by FTX didn’t publicize the company’s solvency issues, well, we’ll all find out during the upcoming bankruptcy proceedings.
They didn't know where funds were, who was using them and what for.
There's also the possibility of exchange insiders trading against user's on-platform stop losses to profit.
>So sure you can have assets that cover all your liabilities one day, then due to a re-valuation, not have enough.
I understood this as a proposal to verify customers could withdraw their deposited coins. If they have traded into another asset, then they would still be able to withdraw. Not sure what you meant here?
>But, all of this neatly misses the point of crypto. If its a practical payment system, rather than an investment, you wouldn't hold your crypto at an exchange. You hold it yourself and move it when you need to convert/liquidate.
Agree about the speculative nature.
It would still create more trust for traders or frequent users of an exchange. Keeping coins off-exchange eliminates the risk entirely. However if users expect to trade on a CEX, they would still have to expose themselves to that risk for the duration of their trade.
Like banks which have to ensure, where I live up to 100k €, customer deposits?
Now there's an opinion which betrays an overwhelming anti-crypto bias.
https://annasofia.xyz/2022/11/05/criticizing-computers.html
Every problem, issue with crypto-tech seems to be solved with yet another layer of crypto-tech. Every criticism of the tech is deflected by pointing at yet another project that is claimed to fix what is being criticized.
Cryptocurrencies have so far not resulted in a compelling use case. All that we are seeing is a questionable solution looking to solve some as yet undiscovered problem.
The parent comment is a bit flippant, but I agree with the thought. The entire crypto industry is rapidly becoming a bizarre and convoluted rube goldberg machine that is completely impenetrable to anyone but the most ardent zealots. Even more, as an outsider it seems like everyone is in this echo chamber of back patting and "with just this one more buzzword bingo sounding feature, we'll have unlocked the true potential of crypto".
Not ever person in the world needs to work on trying to totally reinvent things either. But the idea that something is wrong because it's different than what already exists is ridiculous. It's literally Larry David looking at the wheel in the commercial and saying "seems pointless".
It's a complete failure of imagination.
Awfully lot of trust you seem to need in this fancy world of trustless money of the future.
Right, but if an exchange took out a bank loan, the loan was recalled, and the exchange repaid it with customers' deposited cash and later goes bankrupt - possession is nine-tenths of the law.
Especially if the exchange intentionally has a structure that can avoid international tax laws - who's to say it won't also avoid international bankruptcy laws?
1. How does the exchange ensure money is paid to the customers instead of Mafia or tax authorities?
2. If/when it can't, how these liabilities are included in the proof of liabilities?
(note: this is a real and difficult problem. That's why there are laws, regulations and deposit insurances around customer funds in finance, which, yes, fail occasionally. I just do not see how that can be solved by blockchain.)
Why would they be segregated? The priority of creditors in a bankruptcy proceeding is controlled by courts that will order assets handed over to senior creditors whether they are holding "on chain" liabilities or not. It is the disclosure of such a contract that is the problem of understanding all liabilities, both on and off chain, as bankruptcy court doesn't care about the distinction.
Note that for most exchanges a material portion (most?) of their liabilities will be off-chain—e.g. fiat customer deposits.
It's what one would call a "limited assurance engagement" in audit parlance. In other words, it provides assurance over a small subset of the balance sheet of an exchange - only the customer deposits and the exchange liabilities pertaining to said customers.
However, there are a few red flags which no-one seems to raise:
1) The customer deposits should be off balance sheet if they actually were held in custody. If deposits are not off balance sheet then customer assets cannot be held in custody. Instead, the customers are a creditor of the exchange.
2) From the terms and conditions I've read for various exchanges, customers are typically not treated as a preferential creditor.
3) In the event of an insolvency, customers are treated pari passu with other creditors.
4) To get sufficient assurance that the exchanges can honour their customer liabilities, we need to see ALL of the liabilities, not just the subset relating only to customer deposits. E.g. Who else is money owned to? Did they issue debt? Did they borrow from a bank? Are there any legal provisions? Etc...
5) Given the legal treatment of customers as unsecured creditors, without entire visibility of the balance sheet, the "proof of reserves" report is pretty much useless.
Worse, it provides false assurance that allows the operators of the exchange to loot the exchange more easily.
It's yet to be seen whether proof-of-holdings is practicable for crypto assets, let alone for real world assets. But it is an interesting use case for zero knowledge protocols that could tackle some very real problems. Yes, we have auditors in the real world, and I'm not thinking of replacing them, but it could improve audits. As one example, not too long ago there was a crash of a German payments provider of a scale not much smaller than FTX (Wirecard) that was audited by one of the major firms (EY), who missed a fake $2bn bank deposit claim.
The scale and the percentage of "legit" to "scam" definitely is.
The current process basically looks like this: an auditor will ask the bank to confirm that client X has such and such balance with them. Of course, the bank needs to be sure that the auditor is actually who they claim they are, so they get in touch with their client to confirm that they can tell the auditor their balance. Since this is a bit tricky if the auditor doesn't have a direct line of communication with the bank already, it is often facilitated by the client directly asking the bank to issue a balance confirmation to the auditor, and that's an entry point for impersonation attacks (in an overly simplified manner, that's also what happened at Wirecard). We probably don't need the exact fancy machinery of Merkle sum trees and zero knowledge proofs outlined in the OP, we also don't want to bring in blockchains, but I was wondering whether we could use some of those ideas to make the audit process for normal firms a bit safer.
Sure, and droughts aren't exclusive to the desert either, but I've been living in a desert for the past 4 months and I'm yet to see it rain.
The problem with crypto is that the bulk of the value is created through seigniorage of the tokens required to make it work, not actual utility derived from its technical features, for example better privacy or enabling new transactions.
So in reality the pump & dump, rugpull and speculative bubble dynamics are characteristic to crypto because there is very limited actual wealth created and a massive conflict of interest from the players to cash in on the juice flowing though their systems, which are nothing else than unregulated and inferior copycats of existing financial institutions, state issued currencies, banks etc.
Yeah, being first in a Ponzi scheme tend to work well for some people. For every winner in cryptocurrency there are losers as cryptocurrencies are a zero-sum game.
Also it's interesting to note that in regular finance, exchanges and brokerage firms are separate entities .. meanwhile eg FTX was both the exchange and the 'broker'
Edit: just searched twitter and came across someone asking SBF this exact question about the conflict of interest in being both the exchange and broker (of course he was also trading with client funds on top of that..)
https://twitter.com/dwarkesh_sp/status/1593243104114458627
That's currently being resolved with the implementation & adoption of rollups: There're currently multiple efforts towards developing zk-based rollups, with everyone (Polygon, zkSync, Scroll) taking a different approach towards providing it. Right now, optimistic rollups are the dominant rollup strategy right now, with improvements & decentralization already undergoing development & deployment.
Most still have guardrails in place, but it's publicly known & already being worked on.
https://l2beat.com/scaling/risk
You could have an exchange whose users have 2nd-layer channels open to it for all the currencies they trade. Trading can then happen near-instantly with 0 fees. While still centralized, it doesn't need to take custody of any user's funds.
But replace with what? With people like Vitalik? He seems to be an influential figure and calling the shots. How is this in any way different than a "normal" company with a CEO and a board.
Uniswap was the first well-done AMM (automated market maker) design. It's on version 3 now, and has traded more than $1.2 trillion in volume: https://uniswap.org/
The smart contracts are posted here: https://github.com/Uniswap/v3-core and can be viewed directly onchain as well: https://etherscan.io/address/0x68b3465833fb72a70ecdf485e0e4c...
FTX was primarily used for perpetuals trading, which is a type of leveraged derivative product. Popular decentralized perp products include: GMX: https://gmx.io/#/ and Dydx: https://dydx.exchange/
Vitalik is certainly influential, and he did conceive of and invent the first smart contract blockchain, but he doesn't call the shots any more than Tim Berners-Lee controls the web.
(Parent of copied answer: https://news.ycombinator.com/item?id=33690213)
> But replace with what?
Ideally, open-sourced & audited smart contracts that are ERC-compliant & developed by the general public, with the internal mechanisms made viewable to anyone that wants to learn how such mechanisms work.
> With people like Vitalik? He seems to be an influential figure and calling the shots.
Vitalik can point at where focus could be targeted at, but the decision is ultimately up to the developers themselves. In fact, as far as I can remember, most of the efforts mentioned in the post & image below are not publicly mentioned at all, with other developers leading the charge on that front. (Danksharding being one example, with the development efforts led by Dankrad Feist, hence the name.)
https://twitter.com/VitalikButerin/status/158866978247136870...
https://pbs.twimg.com/media/FgwVhUjaAAEx_Bb?format=jpg&name=...
> How is this in any way different than a "normal" company with a CEO and a board?
The main difference is that development is not wholly left to one party: Anyone can choose to develop the applications that they want to see & deploy them onto the platform. Even if you're external from the main development efforts, you can still contribute to the overall ecosystem with code contributions towards one of the various nodes of the entire system. This stands in contrast with a standard company, where external development's forbidden outside of a special area designated for the general public to interact with.
I fully expect that system to come crashing down in 5-10 year.
He already did that once, and could do it again.
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Don’t get me wrong, I think it’s great. In the US, it’s mostly the worst folks actually losing to this game and I’m overall entertained.
edit: I should maybe clarify that my crypto holdings are now about $20, entirely from folks losing bets to me.