Grayscale Says No To Proof of Reserves

The cryp­tocur­ren­cy indus­try was built on top of one slo­gan: “don’t trust, ver­i­fy.” But Grayscale is dif­fer­ent from the rest of the cryp­tocur­ren­cy-relat­ed businesses.

In a recent Twit­ter thread pon­der­ing the need for trans­paren­cy in the indus­try after the col­lapse of FTX, Grayscale attempt­ed to calm its investors’ fears, assur­ing them that the reg­u­la­tions that apply to its var­i­ous enti­ties make an FTX-like sce­nario near­ly impossible.

Grayscale Says: Funds Are Safe, Trust Us

Grayscale assures that each of its prod­ucts is duly reg­is­tered as a sep­a­rate enti­ty with its own reg­u­la­tions. They explain that the laws and reg­u­la­tions gov­ern­ing each of its cryp­to trusts pre­vent under­ly­ing assets from being sold, loaned, or oth­er­wise transferred.

In a sub­se­quent tweet, Grayscale assures that its cryp­tocur­ren­cies are held by the cus­tody ser­vice pro­vid­ed by Coin­base, the only reg­u­lat­ed and pub­licly trad­ed cryp­tocur­ren­cy exchange in the Unit­ed States.

But now comes the awk­ward ques­tion. What about proof of reserves? Grayscale declined to do such a thing, cit­ing secu­ri­ty rea­sons. They explain that Coin­base, as cus­to­di­an, does per­form peri­od­ic val­i­da­tions, but as such, they would not dis­close address­es or any infor­ma­tion con­sid­ered con­fi­den­tial so as not to affect the nature of their products:

6) Coin­base fre­quent­ly per­forms on-chain val­i­da­tion. Due to secu­ri­ty con­cerns, we do not make such on-chain wal­let infor­ma­tion and con­fir­ma­tion infor­ma­tion pub­licly avail­able through a cryp­to­graph­ic Proof-of-Reserve, or oth­er advanced cryp­to­graph­ic account­ing procedure.

— Grayscale (@Grayscale) Novem­ber 18, 2022

Does Proof of Reserves Really Matter?

The Proof of Reserves is sim­ply a way for users to prove that an inde­pen­dent audi­tor stud­ied and proved the reserves of a spe­cif­ic exchange or busi­ness. It uses Merkle Trees to cap­ture data and get a set of fin­ger­prints that let users ver­i­fy that their funds were prop­er­ly audit­ed by a third party.

The propo­si­tion for proof of reserves has start­ed to get a lot of buzz in the cryp­tocur­ren­cy com­mu­ni­ty in the wake of the FTX melt­down, the lat­est vic­tim of a cryp­tocur­ren­cy win­ter that has tak­en down indus­try heavy­weights such as Ter­ra, 3AC, and Cel­sius.

The idea is to pro­vide a way for users to ver­i­fy a business’s assets via cryp­to­graph­ic tech­niques that ensure data trans­paren­cy. Binance recent­ly agreed to work along­side Vita­lik Buterin to imple­ment a new proof-of-reserves pro­to­col that is sup­posed to be more effi­cient and secure than the cur­rent methods.

How­ev­er, Grayscale is adamant that some things should be kept secret.

7) We know the pre­ced­ing point in par­tic­u­lar will be a dis­ap­point­ment to some, but pan­ic sparked by oth­ers is not a good enough rea­son to cir­cum­vent com­plex secu­ri­ty arrange­ments that have kept our investors’ assets safe for years.

— Grayscale (@Grayscale) Novem­ber 18, 2022

Grayscale cur­rent­ly holds the largest cryp­tocur­ren­cy trust in the indus­try, to the point where it was con­sid­ered the best way to get expo­sure to the cryp­tocur­ren­cy mar­ket among insti­tu­tion­al clients. How­ev­er, fol­low­ing the cryp­to win­ter, each share of the trust has trad­ed about 40% below the price of BTC as an under­ly­ing asset.

Grayscale has also tried to con­vert its trust into a Bit­coin ETF, but the SEC has not giv­en the thumbs up for the project to continue.