Vitalik Buterin proposed a "decentralized exchange protected by encryption," CZ responded that he will fully support it.
Recently, the snowball effect of the FTX bankruptcy has not stopped, and discussions on Proof of Reserve have been heated. Vitalik Buterin published a lengthy article over the weekend titled "Secure Centralized Exchanges: Proof of Solvency". In the article, in addition to discussing the technical aspects of Proof of Reserve, he also proposed "cryptographically protected" centralized exchanges, where user funds are held in smart contracts similar to validium to prevent unauthorized access to user funds. CZ also immediately responded with a post, expressing strong support and pledging to have his team work on implementing these ideas.
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Current Forms of Exchanges
Ethereum co-founder Vitalik Buterin pointed out in an article that exchanges can be divided into two types: custodial exchanges and non-custodial exchanges. Each has its own advantages and risks, as listed below:
Common issues that users often encounter, such as forgetting passwords, losing devices, being hacked, or unable to access their accounts, can be resolved by centralized exchanges, i.e., custodial exchanges, through email or through KYC recovery processes to help customers solve problems. However, because of this, exchanges need to have actual control, and they can reclaim user account funds for legitimate reasons or maliciously steal user funds, which is an inevitable trade-off.
The ideal long-term solution relies on self-custody, supplemented by technologies such as multi-signature and social recovery wallets to help users deal with emergencies.
Other Possibilities for Future Exchanges
Of course, exchanges are not limited to the two aforementioned absolute classifications. In fact, there are various options, including various forms of hybrid centralization, which can offer some benefits such as efficiency while still having many cryptographic safeguards to prevent centralized exchanges from engaging in abuse.
Vitalik also proposed that people's future expectations for exchanges go beyond providing proof of being able to reimburse all user funds, but also further prevent exchanges from stealing user funds. Starkware's validium technology may solve this problem, leading to the potential emergence of "cryptographically protected" centralized exchanges in the future. By using validium smart contracts, exchanges cannot steal funds, but based on current implementation details, if the exchange's operation encounters problems, it may result in user funds being locked.
In the long run, Vitalik hopes that cryptocurrency exchanges will move towards non-custodial solutions. Wallet recovery functions will exist, and highly centralized recovery options may need to be provided for handling small transactions for new users and institutions that require such arrangements for legal reasons, but this can be done at the wallet level without involving exchanges, as seen in the collaboration between Magic and the Polymarket platform.
CZ Expresses Strong Support
Vitalik also mentioned in the article that the simplest way to enhance the security of custodial exchanges is through Proof of Reserve, which includes asset proof and liability proof. This poses technical challenges, but Vitalik hopes that everyone should strive to overcome them and open-source their software and processes for the benefit of all exchanges.
Previously, during a livestream, Binance founder CZ stated that he would collaborate with Vitalik to introduce a new Proof of Reserve method, with Binance serving as a pilot. Following the publication of this article, CZ immediately expressed his support and emphasized that the Binance team will put it into practice and open-source it for the entire industry.
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