March 30, 2017

Provisions: how Bitcoin exchanges can prove their solvency

Millions of Bitcoin users store their bitcoins with online exchanges (e.g. Coinbase, Kraken) which store bitcoins on their customers’ behalf. They present an interface that looks somewhat like an online bank, allowing users to log in and request payments to other users or withdrawals. For many users this approach makes a lot more sense than the traditional approach of storing private keys on your laptop or phone and interacting with the Bitcoin network directly. Online exchanges require no software installation, enable a familiar password-based authentication model, and can guard against the risk of losing funds with a stolen laptop. Online exchanges can also improve the scalability and efficiency of Bitcoin by settling many logical transactions between users without actually moving funds on the block chain.

Of course, users must trust these exchanges not to get hacked or simply abscond with their money, both of which happened frequently in the early days of Bitcoin (nearly half of exchanges studied in a 2013 research paper failed). Famously, Mt. Gox was the largest online exchange until 2014 when it lost most of its customers’ funds under murky circumstances.

It has long been a goal of the Bitcoin community for exchanges to be able to cryptographically prove solvency—that is, to prove that they still control enough bitcoins to cover all of their customers’ accounts. Greg Maxwell first proposed an approach using Merkle trees in 2013, but this requires revealing (at a minimum) the total value of the exchange’s assets and which addresses the exchange controls. Exchanges have specifically cited these privacy risks as a reason they have not deployed proofs of solvency, relying on trusted audit instead.

In a new paper presented this month at CCS (co-authored with Gaby G. Dagher, Benedikt Bünz, Jeremy Clark and Dan Boneh), we present Provisions, the first cryptographic proof-of-solvency with strong privacy guarantees. Our protocol is suitable for Bitcoin but would work for most other cryptocurrencies (e.g. Litecoin, Ethereum). Our protocol hides the total assets and liabilities of the exchange, proving only that assets are strictly greater than liabilities. If desired, the value of this surplus can be proven. Provisions also hides all customer balances and hides which Bitcoin addresses the bank controls within a configurable anonymity set of other addresses on the block chain. The proofs are large, but reasonable to compute on a daily basis (in the tens of GB for a large exchange, computable in about an hour). Best of all, it is very simple and fast for each user to verify that they have been correctly included. We can even extend the protocol to prevent collusion between exchanges. The details are in the paper, the full version of which is now online.

While our Provisions protocol removes the privacy concerns of performing a cryptographic proof-of-solvency, there are still some practical deployment questions because the proof requires the exchange to compute using its private keys. Exchanges rightly go to great lengths to protect these keys, often keeping them offline and/or in hardware security modules. Performing a regular solvency proof requires careful thinking about the right internal procedure for accessing these keys.

These deployment questions can be solved. We hope that cryptographic proofs of solvency will soon be expected of upstanding exchanges. Incidents like that of Mt. Gox have greatly damaged public perception of the entire Bitcoin ecosystem. While solvency proofs can’t prevent exchange compromises, they would have made Mt. Gox’s troubles public earlier and more clearly. They would also shore up confidence in today’s exchanges which are (presumably) solvent.

Taking a step back, solvency proofs are yet another example where we can replace an  expensive and trust-laden process in the offline world (financial inspection by a trusted auditor) with a “trustless” cryptographic protocol. It’s always exciting to take a new step in that direction. There remain limits as to what cryptography can do though. Critically, solvency proofs do not create a binding obligation to pay. A malicious exchange could complete a Provisions proof and then immediately abscond with all of the money. For this reason, some form of government regulation of online exchanges makes sense. Though regulation is dreaded by many in the Bitcoin community, it appears to be on the horizon. Bills have been proposed in several states, largely aimed at exchanges. Interestingly, the model regulatory framework proposed by the Conference of State Bank Supervisors in September already mentions cryptographic solvency proofs as a means of demonstrating solvency. We hope this recommendation is enacted in law and solvency proofs are a tool to avoid the cost of the heavyweight auditing requirements traditionally demanded of banks, while simultaneously increasing transparency for exchange customers.

Comments

  1. Christopher Camp says:

    Great to hear about this advance – well done!

    Some day proof of solvency will be standard issue for financial custodians. And none too soon.

    posting to r/bitcoin, it should get some attention now that the price frenzy has cooled.

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