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Buterin: How to Make CEX Safer Using Cryptography

UTC by Babafemi Adebajo · 3 min read
Buterin: How to Make CEX Safer Using Cryptography
Photo: Unsplash

Buterin suggests using cryptographic proofs to show there are enough funds at all times on change to cover any liabilities to users.

Ethereum co-founder Vitalik Buterin has noted that to make CEX safer, there is a need to incorporate cryptography. Despite the current challenges with CEX, Buterin noted that CEX will continue to exist with DEX. However, he stated an improvement is necessary following the recent FTX collapse.

The Need for Safer Exchanges

With FTX’s collapse bringing increased scrutiny of centralized exchanges, many investors are turning to alternatives. After Liquid Global and BlockFi also paused withdrawals, panicking investors transferred record amounts of cryptocurrency out of exchanges. According to data from CryptoQuant, as many as 742,401 Bitcoin left exchanges last week.

With many turning to self-custody, there was also a surge in hardware wallet sales. Binance CEO Changpeng Zhao noted that “self-custody is a fundamental human right.” Similarly, DappRadar advised investors to avoid keeping their assets on centralized exchanges. The firm noted that retrieving them may be more complex than with traditional financial institutions and exchanges.

Given the panic around the safety of storing assets on Centralized exchanges, Buterin’s suggestions provide a way to make centralized exchanges more trustless. Essentially, Buterin suggests using cryptographic proofs to show there are enough funds at all times on change to cover any liabilities to users.

How to Make CEX Safer

The idea in itself is simple. If exchanges can prove the total amount of deposits and the ownership of private keys to the assets, we have proof of solvency. In this case, evidence of solvency refers to the ability of the exchange to pay back the depositors in the event of a problem.

While noting that on-chain DEX was equally not the solution due to inefficiency and privacy issues, Buterin noted there were safe options between both CEX and DEX.

While exchanges could simply publish a report of all transactions involving locked assets, that creates privacy problems. Consequently, the Merkle tree technique was created. In this tree, the exchange puts the table of customers’ balances into a Merkle sum tree, where each node is a (balance, hash) pair. The balances and username hashes of individual depositors are represented at the bottom leaf node.

Asides from this, a ZK-SNARK can help prove balances are non-negative and add to the total deposit value claimed by the exchange. With an extra layer of hashing, you can further improve privacy so exchange users cannot learn about the balances of other users.

Securing Investor Assets

According to Buterin, “The ideal long-term solution is to rely on self-custody, augmented by technologies such as multisig and social recovery wallets to help users deal with emergency situations.”

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