The collapse of numerous major crypto ecosystems in 2022 revealed the urgent need for revamping the way crypto exchanges operate. Ethereum (ETH) co-founder Vitalik Buterin believed in exploring beyond “fiat” methods to ensure the stability of crypto exchanges, including technologies such as Zero-Knowledge Succinct Non-Interactive Argument of Knowledge (ZK-SNARKs).
Following a discussion with angel investor Balaji Srinivasan and crypto exchanges such as Coinbase, Kraken and Binance, Buterin recommended options for the creation of cryptographic proofs of on-chain funds that can cover investor liabilities when required, a.k.a, safe centralized exchanges (CEX).
Having a safe CEX: proof of solvency and beyondhttps://t.co/AKEweYZfj2
— vitalik.eth (@VitalikButerin) November 19, 2022
The best case scenario, in this instance, would be a system that does not allow crypto exchanges to withdraw a depositor’s funds without consent.
Vitalik’s new ideas. Working on this.
Just don’t read the title aloud around people (Vitalik wrote it).https://t.co/AtR6KiSx5B
— CZ Binance (@cz_binance) November 19, 2022
Fellow crypto entrepreneur CZ, who has been vocal about Binance’s intent for complete transparency, acknowledged the importance of Buterin’s recommendations, stating that:
“Vitalik’s new ideas. Working on this.”
The earliest attempt to ensure fund safety was proof-of-solvency, wherein crypto exchanges publish a list of users and their corresponding holdings. However, privacy concerns eventually fueled the creation of the Merkle tree technique — which dampened the privacy leakage concerns. While explaining the inner workings of the Merkle tree implementation, Buterin explained:
“The Merkle tree technique is basically as good as a proof-of-liabilities scheme can be, if only achieving a proof of liabilities is the goal. But its privacy properties are still not ideal.”
As a result, Buterin placed his bets on cryptography via ZK-SNARKs. For starters, Buterin recommended putting users’ deposits into a Merkle tree and using a ZK-SNARK to prove the actual claimed value. Adding a layer of hashing to the process would further mask information about the balance of other users.
Buterin also discussed implementing proof-of-assets for confirming an exchange’s reserves while weighing the pros and cons of such a system, considering that crypto exchanges hold fiat currencies and the process would require crypto exchanges to rely on trust models better suited for the fiat ecosystem.
While long-term solutions will need the involvement of multisig and social recovery wallets, Buterin pointed out two alternatives for the short-term — custodial and non-custodial exchanges, as shown below:
“In the longer-term future, my hope is that we move closer and closer to all exchanges being non-custodial, at least on the crypto side,” added Buterin. On the other hand, highly centralized recovery options can be used for wallet recovery for small funds.
Related: Crypto self-custody a ‘fundamental human right’ but not risk-free: Community
On Nov. 4, Buterin added a new category of milestones to the Ethereum technical roadmap — aimed at improving censorship resistance and decentralization of the Ethereum network.
The updated technical roadmap now inserts the Scourge as a new category, which will run parallel to other previously-known segments — the Merge, the Surge, the Verge, the Purge and the Splurge.