If we claim to be an improvement on traditional finance, we might as well start playing that role. It is clear how Bitcoin solves rampant monetary discretion. It’s also clear how Bitcoin changes your relationship with money – both financially because you’re more likely to save something valuable – and physically because you can do new things like store the GDP of a small island nation on a USB stick. However, there is one thing that is slowly gaining acceptance and must be accepted if we really want to correct the mistakes of the past, and that is the Proof of Reserves.
Bitcoin has unique auditing features baked into the system itself. With Bitcoin, any third party can control the entire money supply down to the smallest unit. A third party can do this for free, without any special privileges or permissions. It is difficult to overstate how new and consequential this feature of the Bitcoin protocol is and the implications of the guarantees it provides. For context, the total global supply of dollars is an estimate and not an exact number, due to a variety of factors, including the existence of physical and digital cash, as well as currency circulation abroad. The total number of gold grades in existence is also an estimate due to entirely different reasons, mainly the lack of certainty when it comes to the amount of gold mined from various mines around the world, gold in private hands, gold deposits and reserves, new mining activities, recycling and unreported sources. There is no global, reliable source of truth for any money or asset other than Bitcoin. And this should be the driving force of Bitcoin.
Proof of Reserves (PoR) has been an important part of the industry since its inception. The infamous Mount Gox collapse in 2014 paved the way for much-needed transparency. The exchange was hacked, 850,000 BTC (~47,617,204,000 USD at the time of this article) was stolen and their customers were unaware. The money ran out over the course of a few years before the actual collapse occurred. A PoR system would have limited further monetary losses, as their customers would see the exchange’s reserves depleted at an alarming rate. If this seems more like recent memory than an old piece of Bitcoin history, that’s because the same argument applies to FTX, and the same basic thing happened to FTX. If customers, and the broader market in general, had seen the exchanges’ BTC reserves depleted in real time (or the fact that FTX had zero Bitcoin), the systemic risk would have been dramatically mitigated.
So what do you think would happen if the sole custodian that holds 90% of the bitcoin that backs these ETFs were hacked and/or acted maliciously? Unless the public is notified by the exchange, millions of people would hold billions of paper Bitcoin. The more we connect with traditional finance, the greater the cross-risk between traditional financial markets and the crypto markets. There are two choices right now as we continue to mature as an asset class: apply old security and risk management tools to this new technology, or apply new, better performing standards that are risk-adapted to ensure we don’t see risk. systemic collapse when a certain class of financial products experiences a shock.
It can be argued that having accountants is enough, that we already have these tools and that, as regulated financial products, they are essentially already ‘taken care of’. This statement is valid in itself, as imposing audit controls to mitigate risk is actually the best thing we have been able to do so far when it comes to financial products. But any meaningful investigation into the function of accountants produces alarming results: PwC versus BDO in the Colonial Bank Case (2017), Grant Thornton versus PwC (Parmalat Scandal, 2003), BDO versus Ernst & Young (Banco Espírito Santo, 2014). ), KPMG vs. Deloitte (Steinhoff Scandal, 2017), and this only looks back twenty years. FTX and Enron both had auditors. We use auditors because we do not trust the people who run the organization. The best we have been able to do so far is transfer trust to another group of people, outside the organization. But the inherent risk of trusting people and organizations has never been resolved until now. Enron’s Biblical collapse was due to a clear conflict of interest between them and their auditor – namely that in addition to their audit function, Arthur Andersen also provided lucrative consulting services to Enron and by extension helped them cook their books.
Bitcoin is different, it behaves and lives differently. It behaves differently because the cryptographic guarantees it provides are something incomparable to traditional assets. Just as anyone can control the entire money supply in the system with reliable guarantees, anyone can also control the personal assets of any individual, company or ETF that holds Bitcoin in a completely risk-free manner. It is an important note that the risk is not reduced, but without risk. Someone who cryptographically proves to another counterparty that they own Bitcoin for a loan, for example, can do so without any doubt as to whether the person is the actual owner of the BTC. This can be done repeatedly, with little overhead, and can be continuously monitored in real time. There is no title listing, there is no external auditor, there is no book review to take place. That data can be included without a doubt.
What does this mean for ETF products? It should be clear at this point that because ETF products are such a critical pillar of our modern financial system, and because Bitcoin introduces unique risk paradigms that old auditing standards under-serve, new risk infrastructure needs to be applied to these products. The solution is simple and it is the same solution that works its way up through the ice we are all standing on in an attempt to get some air. Requires spot Bitcoin ETF products to implement and comply with Proof of Reserves regimes. They should give their investors the peace of mind that the underlying assets backing these ETFs exist, are in robust custodial systems, and are not being re-mortgaged. The ETF issuer’s failure to do this, or unwillingness to do so, speaks to the issuer’s priorities, namely that it does not understand the nature of this particular financial product or that it is more comfortable working with it . opacity than transparency. If this is not implemented as standard across the industry, it is simply a ticking time bomb.
Hoseki was created for this purpose, to build the plumbing that makes Bitcoin financing a reality, starting with the Port Authority. Hoseki helps individuals prove their reserves to counterparties through Hoseki Connect and through Hoseki Verified, provides services to private and public companies and ETF issuers so they can publicly verify their Bitcoin holdings by building better brands, redefining trust and limit risks for a healthier and more robust policy. financial ecosystem. Contact us at partnerships@hoseki.app to connect your organization to Hoseki.
This is a guest post by Sam Abbassi. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.