After the demise of FTX, the necessity for crypto exchanges to rebuild consumers’ trust has risen to the top of the priority list for many stakeholders, including Ethereum co-founder Vitalik Buterin, who has written a blog post on the subject.
Buterin recounted the history of proof of reserves and discussed the limits of the existing techniques used by centralised exchanges to demonstrate a lack of trustworthiness and proposed improvements.
According to him, since Mt Gox’s collapse in 2011, the requirement for exchanges to demonstrate their solvency has been a concern.
These concerns generated debates in 2013 over how exchanges can demonstrate the entire amount of customer deposits and that they have sufficient assets to fund those deposits. This resulted in the current Merkle Tree approach.
Buterin said that the Merkle Tree technique is not entirely secure. Although it is useful for liability evidence, he observed that it posed a privacy concern.
ZK-SNARKs are an improved method for exchanges to verify their reserves and liabilities, thanks to technical improvements.
Buterin also emphasized that, despite the fact that shifting assets from cold wallets to public addresses is a simple way to demonstrate ownership, it is also troublesome. The issues include the simultaneous usage of collateral and the expense of signing off communications to demonstrate address control.
In addition, Buterin said that exchanges may use Plasma and validiums to avoid the misappropriation of customer cash. However, this has drawbacks, such as funds being lost if the operator leaves.
In conclusion, he said that although decentralized exchanges offer benefits, CEXs can assist with account recovery if the user forgets their password.
Buterin also anticipated a future with cryptographically limited CEXs and half-custodial exchanges that retain cash but no cryptocurrency.