How Merkle Trees Make Exchange Funding More Transparent?

With the fall of FTX, investors’ confidence in centralized exchanges has been shaken. Exchanges have announced Merkle-Treeproof-of-reserves to make asset reserves transparent.

MerkleTree Introduction

MerkleTree was originally proposed by Ralph Merkel, a famous computer scientist in the field of public key cryptography. It is a tree-structured data processing system designed to verify the integrity and accuracy of data and is considered an important part of blockchain technology. A MerkleTree is a hash tree in which each leaf node contains the cryptographic hash of a data block, and each non-leaf node contains the label of the cryptographic hash of its child node. This structure makes verifying data integrity efficient and reliable.

The Development and Principle of MerkleTree

In 2014, the Crypto community launched a discussion on how exchanges can prove their reserves to auditors.

In 2019, the market began to study more detailed solutions, and the MerkleTree-based proof model is a solution generally recognized by the market.

PoR (Proof of Reserves) is a method of verifying assets through independent third-party audits. A third-party auditor takes an anonymous snapshot of all account balances, then aggregates this data into MerkleTree, and finally generates MerkleRoot. This approach ensures account transparency and asset authenticity, while also providing users with greater security. Through PoR, users can have more trust in the digital asset reserves declared by institutions on their platforms, thereby reducing potential risks. This kind of transparency and verifiability is crucial for financial institutions and digital asset trading platforms,

Auditors collect digital signatures generated by exchanges that prove ownership of the chain via publicly verifiable balances Address. Finally, auditors compare and verify whether these balances match or exceed the customer account balances shown in MerkleTree to determine whether the exchange has sufficient reserves.

The basis of MerkleTree is to generate a Hash value for the asset data held by each account, and then generate a new Hash from the two Hash values, layer by layer. The final hash contains the total amount of all assets on the exchange.

The verification scheme can ensure the data integrity of the Merkel tree root, thereby proving the integrity of the data in the entire Merkel tree.

Summary

Through the Merkle tree and its upgrades, the assets of centralized exchanges will gradually become transparent, which will be beneficial to the development of the industry.

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