Blockstream is looking to challenge “exchange distrust” by releasing a new open source tool to easily verify Bitcoin “proof of reserves.”
Many Bitcoin exchanges are coming under increasing pressure from users and regulators to prove they are managing their users’ funds correctly. Given some of the recent exchange hacks and thefts over the past few years, proving reserves has become an increasingly important factor for businesses seeking to retain the trust of their customers.
Regarding the recent discussion around exchange distrust, we think it's time for the industry to settle on a standard for proving #bitcoin holdings, so we've published a new open source Proof of Reserves tool. Don't trust. Verify. 📖🔍🔏 https://t.co/uKqlJjLU1x pic.twitter.com/kU8kIesqA6
— Blockstream (@Blockstream) February 5, 2019
Blockstream said in their blog post that “unfortunately, the few exchanges that are taking steps to prove their Bitcoin balances to third parties use their own in-house solutions to generate their proofs.”
With the variety of approaches used, it makes it extremely difficult for anyone wishing to verify exchange holdings for themselves. To make any ‘proof of reserves’ verification, a user must familiarise themselves with each individual system and also possess the specialist technical knowledge to make sure they can adequately trust the data they are being given.
How proof of reserves will work
Blockstream has said that their proof of reserves tool will allow exchanges to easily prove how many Bitcoin they could spend without needing to generate a BTC transaction. This would negate any risk associated with moving reserve funds between addresses.
“Using the tool, an exchange first constructs a single transaction which spends all of an exchange’s Bitcoin UTXOs, and adding an extra invalid input. By including one invalid input, the entire transaction is rendered invalid and would be rejected by the network if broadcast. However, the transaction is constructed in such a way that it can still be used as an explicit proof of all the Bitcoin UTXOs spendable by the exchange.”
Using this method, the transaction data can then be shared with anyone to verify the reserves. To do this, users simply need to import the data into their own proof of reserves client to confirm the exchange’s total holdings.
Hardware wallet integration
The proof of reserves tool currently supports both the Bitcoin Core and Trezor hardware wallets, with Ledger support and more integrations also on the way. As part of the software development, the tool has also been fully open sourced and proposed as a BIP (Bitcoin improvement proposal) to the Bitcoin developer mailing list.
Blockstream concluded that their solution is “easy-to-use and accessible to anyone that knows how to run a CLI application.”
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.