Proof of Ownership in Crypto: How It Works
Filip Dimkovskion August 1, 2022.
In the past decade, we have seen the rise of a new form of asset class—cryptocurrencies. A key feature that sets cryptocurrencies apart from other asset classes is that they are digital and decentralized, meaning that there is no central authority that controls or issues them. Instead, they are produced by a computer network that runs on a decentralized ledger called a blockchain.
Although decentralization brings many benefits, it also carries some problems—specifically regarding ownership. Stocks and bonds, for example, are issued by a central authority, so you can quickly get a document proving your assets' ownership. But, on the other hand, no one can explicitly confirm that the wallet where you hold your crypto is yours—unless you prove it with a private key.
However, giving your private key to someone has inherent privacy problems. A private key is your wallet's password, meaning anyone who has it can directly access your crypto assets. So, how can you prove that you're the true and only owner of your crypto assets? Read on to find out.
How Proof of Ownership Works in Crypto
There are three main ways to prove ownership of your crypto. Let's take a look at each one and see how it works.
1. Doing a Test Transaction
Let's say that you want to prove to an institution (like a bank) that you hold a specific amount of crypto. You could tell them your wallet's public key, and they could open the blockchain explorer and check the amount held within the address. However, you still haven't proven that the wallet is yours.
To do this, you could send a specified amount (an amount the bank would require) from that public address to the bank's address. Thanks to the transparency of blockchain technology, there's no way to falsify this. So, once you make the transaction, it will be imprinted on the blockchain forever, and you have proven ownership of the account.
2. Getting a Printed Statement
This is perhaps the easiest method of proving ownership of a crypto wallet, though most central authorities would regard it as the least authentic one. Namely, getting a printed statement is done by exporting the transaction history from your wallet or exchange. Once you have the statement as a PDF, you can print it and take it to a legal authority like a notary public to verify its accuracy.
However, it's easy to see why most central authorities wouldn't settle just for a printed statement regarding crypto proof of ownership. Although it's illegal, a printed statement is relatively easy to falsify with just a bit of graphic design knowledge. So, in most cases, a printed statement will be required as an additional ownership verification method.
3. Signing a Message With a Private Key
In cryptography, a message can be signed with a public or private key (both are used in blockchain technology). As with cryptocurrency, a public key is something you share with everyone, while the private key is the instrument giving you access to your wallet.
This is where signing a message with a key comes in. All tokens in cryptocurrency use specific cryptographic algorithms (BTC uses SHA256, ETH uses keccak256 and ECDSA). With these algorithms, a sender can encrypt a message with the wallet's public key, and the only one who can decrypt it is—you guessed it—the one who holds the private key.
Let's take a look at a typical example of this. You want to submit proof of ownership to a bank of a crypto account that you claim is yours, but you can't prove it yet. You tell the bank your public key, and they check it on the blockchain and see the assets held on it. Then, using it, the authority (in this case, the bank) signs a message with the public key as an encryption tool. Thanks to cryptography and the way blockchain technology works, you can use your private key to decrypt it and verify the message. You've now proven ownership of the crypto wallet in question.
When Proof of Crypto Ownership Is Needed
In TradFi (the traditional finance system), there are multiple scenarios where you might need to prove ownership of an account or asset. For example, when opening a bank account, you will be asked to provide some form of identification like a passport or driver's license. A similar point could be made for investing in stocks and bonds. You will likely go through a KYC (know your customer) process to prove that you are who you say you are and that the money you're using to invest comes from a legitimate source.
The same goes for crypto. Although crypto exchanges and wallets aren't regulated the same way as traditional financial institutions, there still are some scenarios where you'll need to prove ownership of a crypto account. For example, suppose you want to open an account at a bank that supports cryptocurrency. In that case, they will likely require some form of proof of ownership for your crypto account.
Similarly, if you want to use your crypto assets as collateral for a loan, the lending institution will also require proof that you own those assets. Taking out loans with crypto is, in many cases, cheaper than in the traditional finance system since the APY in crypto is often better. Of course, traditional finance works much differently than DeFi—read our beginner's guide to decentralized finance to learn more.
Nevertheless, in all proof of ownership cases, it's up to the bank or lending institution to decide what type of proof they will accept. Some might accept a printed statement, while others might require a signed message.
How to Prove Ownership of Crypto Assets
As we've seen, there are a few different ways to prove ownership of crypto assets. In most cases, you will need to provide a combination of the methods we've discussed above. The exact proof of ownership requirements might vary, but in general, you will need to provide some or all of the following:
- Your full name and address
- A copy of your passport or driver's license (or another form of government-issued ID)
- The cryptocurrency wallet address in question
- A signed message from that wallet
- A printout of the wallet's contents
Again, the specific requirements will vary depending on the institution you're dealing with. For example, suppose you're trying to open a bank account that supports cryptocurrency, and you'd like to use that crypto for yield farming strategies. In that case, they might only require your name, address, and ID. However, if you're trying to use your crypto assets as collateral for a loan, the lending institution will likely require more information, such as your wallet address or a signed message.
Ultimately, it's up to the individual institution or authority to decide what type of proof they will accept.