Ethereum co-founder Vitalik Buterin published a blog post about past efforts to bring centralized exchanges (CEX) closer to trustlessness, the drawbacks of existing strategies, and some new potent concepts that depend on ZK-SNARKs and other technologies.
Contributors to Vitalik’s study included a16z general partner and former Coinbase CTO Balaji Srinivasan, and staff from Binance, Coinbase, and Kraken.
Buterin noted balance lists and Merkle trees are old-school proof-of-solvency methods. Buterin added the earliest attempts by exchanges to try to cryptographically prove that they are not cheating their users go back quite far quoting Bitcoin exchange MtGox.
Buterin states that the Merkle tree technique is basically as good as a proof-of-liabilities scheme can be, if only achieving proof of liabilities is the aim and its privacy properties are still not ideal.
He further added about how we can improve privacy and robustness with ZK-SNARKs. Buterin stated we can put all users’ deposits into a Merkle tree or a KZG commitment, and use a ZK-SNARK to prove that all balances in the tree are non-negative and add up to some claimed value.
“In the longer-term future, this kind of ZK proof of liabilities could perhaps be used not just for customer deposits at exchanges, but for lending more broadly,” Buterin claimed.
Buterin noted two practical problems with this simple proof-of-assets technique which are ‘dealing with cold storage’ and ‘collateral dual-use’.
To solve this, exchanges can keep a few public long-term-use addresses, have many addresses, and prove a few randomly.
The exchanges could even run a zero-knowledge proof over the blockchain where it proves the total balance of all addresses on-chain that have this format, to preserve privacy.
To make CEXes non-custodial Buterin suggests Plasma and validiums methods. Ethereum scaling solution Plasma works by splitting up the balance into a set of individual “coins”, where each coin is assigned an index and lives in a particular position in the Merkle tree of a Plasma block.
The more modern implementation of the Plasma concept is a validium, which is essentially a ZK-rollup with the exception of where data is stored off-chain.
In a validium, the operator has no method to steal money, yet, depending on the implementation’s specifics, a certain amount of user money might become trapped if the operator vanishes.
“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,” the Ethereum co-founder concluded.
Vitalik published this study in the wake of the CEX FTX crash. Vitalik Buterin dumped 3000 ETH tokens during the FTX hack. He exchanged these ETH for $4 million USDC in three transactions on November 12 on the DeFi automated market maker Uniswap V3.
