Blockstream that develops solutions for the Bitcoin ecosystem designed a new instrument Proof of Reserves. It will enable exchanges to confirm that they have enough funds in the major cryptocurrencies.
The solution is said to be initially created for the Liquid sidechain to show third-party auditors whether its users have L-BTC or not. However, developers realized later the fact that the software can be applied outside of the Liquid Network.
"We’ve been working on a solution to provide a best-practice standard Proof of Reserves for the industry, that offers broad compatibility with the way most Bitcoin exchanges are storing their users’ funds," as the company stated in the press release.
According to the project team, the Proof of Reserves solution enables trading platforms to see how much bitcoins it can spend "without needing to generate a “live” transaction or exposing themselves to the risks of moving funds." Technically, the tool creates a transaction that uses all unspent transaction outputs (UTXO) of exchange and adds one invalid output. This output will make the entire transaction invalid, and the network will not accept it. Nevertheless, the data can be used by external auditors to confirm that an exchange is a solvent.
Blockstream developers have already made a relevant Bitcoin Improvement Proposal (BIP) and the Proof of Reserves code public. At present, the proves that is created by the tool may contain too much crucial information to be made public. As a result, one can use the Liquid sidechain to confirm solvency or wait for an updated version of the software.
Notably, the Liquid sidechain was launched in October 2018. It was developed to transfer large amounts of bitcoins between exchanges and other infrastructure elements of the cryptocurrency ecosystem.