If we are to be an improvement over traditional finance, we better start playing that role. It is clear how Bitcoin solves the rampant monetary discretion. It's also clear how Bitcoin changes your relationship with money, both financially because you're more inclined to save an appreciating asset, and physically because it can do novel things like keep the GDP of a small island nation on a USB. However, there is one thing that is slowly gaining acceptance and that must be accepted if we really want to improve on the mistakes of the past: proof of reserves.
Bitcoin has unique auditing properties built into the system itself. Bitcoin allows any third party to audit the entire monetary supply down to the smallest unit. A third party can do this for free, without special privileges or permissions. It is difficult to overestimate how novel and momentous this property of the Bitcoin protocol is and the implications of the guarantees it offers. For context, the total global supply of dollars is an estimate and not an exact figure due to a variety of factors including the existence of physical and digital cash, as well as the circulation of currencies abroad. The total number of gold in existence is also an estimate due to completely different reasons, mainly the lack of certainty regarding the volume of gold extracted from different mines around the world, the existing gold in private hands, gold reserves and caches, new mines. , recycling and undeclared sources. There is no global, reliable source of truth for any money or product other than Bitcoin. And this should be the driving force for Bitcoin in the future.
Proof of Reserves (PoR) has been an important part of the industry since almost its inception. The infamous Mt. Gox collapse in 2014 set the stage for much-needed transparency. The exchange was hacked, 850,000 BTC (~$47,617,204,000 at the time of writing) was stolen and its customers didn't know it. The funds were depleted over the course of a few years before the actual collapse occurred. A PoR system would have mitigated further loss of funds as its clients would have seen the exchange's reserves deplete at an alarming rate. If this sounds more like a recent memory than an old piece of Bitcoin history, it's because the same argument applies to FTX, and the same thing happened to FTX. If customers, and the market at large, had seen exchanges' BTC reserves depleting in real time (or the fact that FTX was out of Bitcoin), systemic risk would have been drastically mitigated.
So what do you think would happen if the sole custodian that owns 90% of the Bitcoin spot that backs these ETFs were hacked or acted maliciously? Unless the exchange notifies the public, millions of people would hold billions of Bitcoin on paper. The more we connect with traditional finance, the greater the crossover risk between traditional financial markets and crypto markets. There are two options at this point as we continue to mature as an asset class: apply old security and risk management tools to this new technology, or apply new, more efficient, risk-adjusted standards to ensure we don't see a systemic collapse if a certain class of financial products experiences a shock.
It can be argued that having auditors is enough, that we already have these tools and, as regulated financial products, this is essentially already “solved.” This statement, in itself, is valid since imposing audit controls to mitigate risk is, in fact, the best thing we have been able to do so far when it comes to financial products. But any meaningful investigation into the role of auditors yields alarming results: PwC vs. BDO in the Colonial Bank Case (2017), Grant Thornton v. PwC (Parmalat Scandal, 2003), BDO vs. Ernst & Young (Banco Espírito Santo, 2014), KPMG vs. Deloitte (Steinhoff Scandal, 2017), and this is just looking back 20 years. Both FTX and Enron had auditors. We use auditors because we don't trust the people who run the organization and the best we have been able to do to date is transfer trust to a different group of people, outside the organization. But the inherent risk of trusting people and organizations has never been remedied until now. Enron's biblical collapse was due to a clear conflict of interest between them and their auditor, namely that Arthur Andersen was also providing lucrative consulting services to Enron in addition to their audit function and, by extension, helping them prepare their books.
Bitcoin is different, it behaves and lives differently. It behaves differently because the cryptographic guarantees it exhibits are incomparable to traditional assets. Just as anyone can audit the entire money supply in the system with trustless collateral, so can anyone audit the personal holdings of an individual, corporation, or ETF, holding Bitcoin in a completely risk-free manner. It is an important note that it does not mitigate the risk, but rather eliminates it. Someone cryptographically proving to any other counterparty that they hold Bitcoin for, say, a loan can do so without doubting whether the person is the actual owner of the BTC. This can happen repeatedly, with little overhead, and can be continuously monitored in real time. There is no qualification, there is no external auditor, there is no review of any book that must be carried out. This data can be ingested without a doubt.
So 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 are not adequately addressed by old auditing standards, a new infrastructure needs to be applied. of risk to these products. The solution is simple and it is the same solution that has been climbing through the ice we are all standing on in an attempt to get some air. Require spot Bitcoin ETF products to implement and comply with Proof of Reserves regimes. They should give their investors peace of mind that the underlying asset backing these ETFs exists, that they are in strong custodial setups, and that they are not being remortgaged. The failure to do so, or the unwillingness to do so on the part of the ETF issuer, speaks to the issuer's priorities, i.e. that they do not understand the nature of this particular financial product or are more comfortable trading it. opacity than transparency. Not implementing this as an industry-wide standard is simply a ticking time bomb.
Hoseki was created for precisely this purpose, to build the pipelines that make the financialization of Bitcoin a reality, starting with PoR. Hoseki helps people prove their reserves to their counterparts through Hoseki Connect and through Hoseki Verified serves public and private corporations and ETF issuers so they can publicly verify their Bitcoin holdings, building better brands, redefining trust and mitigating risk for a healthier, more robust life. financial ecosystem. Contact us at partners@hoseki.app to add 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.
