Exploring the tech behind crypto

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Hi, Bradley Keoun here, editor of The Protocol.

Crypto accounting became a hot topic after last year’s collapse of Sam Bankman-Fried’s FTX, which spurred jitters and led to added scrutiny of the reserves backing exchanges like Binance or asset-backed tokens such as the dollar-linked stablecoin Tether. One solution is Chainlink’s “Proof of Reserve” product designed to provide a real-time data feed to blockchain developers. But as our Sam Kessler reports, the service is only as good as the data that’s being fed into it.

Also in this week’s issue of The Protocol, we highlight the market resurgence of vintage cryptocurrencies like bitcoin cash (BCH) and litecoin (LTC), a software audit for Coinbase's planned Base blockchain and the new "Quantum Leap" upgrade for the Ethereum-focused blockchain project Starknet.

Chainlink ‘Proof of Reserve’ Proves Little Beyond Data Going In, Coming Out

Sergey Nazarov (Chainlink Labs)

Crypto infrastructure firm Chainlink claims its proof-of-reserves service – designed to help users verify that exchanges and asset managers have the backing they profess – “enables the reliable and timely monitoring of reserve assets using #ProofNotPromises.”

In reality, the system frequently relies on promises all the way down.

Chainlink Proof of Reserve is one of the only ways for crypto custodians to track real-world assets directly on blockchains, a service that unlocks a host of safety and transparency benefits for the end-users of decentralized finance (DeFi) products.

However, rather than help crypto users transact with more confidence and transparency, Chainlink’s reserve tech can also provide them with a false sense of security – adding a veneer of legitimacy and “decentralization” to the same inadequate accounting practices that were exposed by the collapse of the FTX exchange.

When it comes to integrating centralized data into decentralized protocols, a deep dive into Chainlink’s proof-of-reserves tech shows how “promises,” not “proof,” are often the best that one can realistically hope for.

Network News

Co-founders Uri Kolodny and Eli Ben-Sasson of StarkWare, the developer behind Starknet. (Natalie Schor/StarkWare)

Out with the new, in with the old. Older-vintage cryptocurrencies relying on the same proof-of-work security mechanism that Bitcoin uses are back in vogue, rallying in digital-asset markets as the U.S. Securities and Exchange Commission steps up scrutiny of other, popular altcoins that might be due to undergo more rigorous regulation. Bitcoin Cash (BCH), which hard-forked off the main Bitcoin blockchain in 2017, has more than doubled in price in the past 30 days. Bitcoin SV, another Bitcoin fork from 2017, is up 35% during the period. Litecoin, a 2011 Bitcoin fork, rose about 28% in the seven days through July 2. “Litecoin is a derivative of Bitcoin and operates on a proof-of-work blockchain, so it is improbable to be regarded as a security, which might be causing an uptick in market sentiment,” CryptoSlate reported. Meanwhile the digital banking service Revolut is preparing to delist tokens including Cardano’s ADA, Polygon’s MATIC and Solana’s SOL. The Blockchain Association is pushing back against the SEC’s campaign, arguing that Chair Gary Gensler should recuse himself from any decisions regarding “an enforcement action premised on the theory that a digital asset is a security.”

Polygon’s layer 2 status still up for debate. It might be one of the most arcane debates ever, but a flurry of recent announcements from Polygon recently have failed to resolve the question of whether the project’s original “PoS” chain qualifies as a legitimate “layer 2” atop Ethereum. According to the project’s website, the network has tens of thousands of decentralized apps, more than 3 million average daily transactions and $5 billion in secured assets. But crypto analysts argue it’s not a true “layer 2,” rather more of a “sidechain” or just a “scaling solution.” Just last month, Polygon proposed to turn the PoS chain into something known as a zkEVM validium, a move that could resolve several tech challenges including a “suboptimal security model,” according to the crypto financial firm Galaxy Digital. But in a recent report the Galaxy analyst Charles Yu immediately pivoted to discussing “whether Polygon is technically an ‘L2.’” There “continues to be debate,” he wrote. The sticking point is that the validium model requires “additional security assumptions with storing offline data,” according to Yu.

Coinbase, the big U.S. crypto exchange,says it’s confident in the security of its forthcoming layer 2 blockchain, Base, after disclosing last week that an internal protocol security team had been commissioned to “battle-test” the underlying code. The team also audited Optimism’s OP Stack – the platform upon which the new chain is being developed. “Completing these in-depth security workstreams without discovering critical severity bugs gave the Base team confidence to proceed towards mainnet launch,” according to a blog post on the Base website.

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Blueish line shows circulating supply of Lido's stETH, versus orange line for Rocket Pool's rETH. (Coin Metrics)

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