Gmaxwell's “prove how (non)-fractional your Bitcoin reserves are” scheme

The developer is Gregory Maxwell, aka nullc. Here's a very interesting thread in which he proposes that the bitcoin community should demand that every bitcoin exchange (and every other type of service which can hold bitcoin on your behalf, like webwallets) continually prove that they are not fractional reserve. In other words, proof that if every user of the service simultaneously tries to withdraw all of their bitcoin, then the service would be able to honor all withdraw requests: http://www.reddit.com/r/Bitcoin/comments/1yj5b5/unverified_p...

"I think that as a community we should start demanding these services continually prove that they are not fractional reserve. We cannot effectively eliminate the need for trust in these sorts of services, but we can certainly confine the exposure and eliminate a lot of this drama. With Bitcoin it's technically possible to prove an entity controls enough coin to cover its obligations— and even to do so in ways that don't leak other business information, and so we should. But this isn't something specific about MTGox, it's something we should demand from all services holding large amounts of third party Bitcoins. I wouldn't even suggest MTGox should do it first, rather— it sounds like a great move for their competition to differentiate themselves."

Here's the takeaway:

"This would leak the total holdings, and some small amount of data about the number of accounts and distribution of their funds, but far far less than all the account balances. Importantly, though— it could be implemented in a few hundred lines of python."

In case anyone from Coinbase is reading: you have a unique opportunity to be the first webwallet service to implement this, and thereby make the entire bitcoin community instantly fall in love with you. It would also set a minimum standard of quality for webwallet services in general, which would add a lot of value to the bitcoin ecosystem. It seems like this might be a pretty big business opportunity.

Fractional reserve? I don't like that. It's like building a house of cards or a ponzi scheme. You shouldn't be able to say you have 10x of the value you actually have.

At first I was worried of what would happen if the exchange introduced fake nodes with negative balances at the bottom of the tree, but there would be no way for them to hide that without the first real customer up to the root finding out (there would have to be a negative node that he/she could see). This sounds like a great idea!

This doesn't give you a way to validate your dollar deposits. In other words a dishonest exchange operator could misappropriate your dollar deposits and this scheme wouldn't tell you anything about it.

Alternatively, a fractional reserve institution can offer interest on accounts which might entice some people to accept the risk of a bank run. Given the popularity of some explicit ponzi schemes in the past month, It seems fairly clear there are plenty of folks who would accept those terms.