U.S. Sens. Thom Tillis (R-NC) and John Hickenlooper (D-CO) introduced legislation that seeks to establish safeguards against instances of unethical co-mingling of customer funds by financial institutions that hold digital assets.
The Proving Reserves of Others Funds (PROOF) Act would establish regulatory standards on how digital asset institutions can hold customer assets, including a prohibition of the co-mingling of customer funds. It would also require digital asset exchanges and custodians to submit to a Proof of Reserves inspection by a neutral third-party.
The lawmakers point out that the implosion of the digital asset platform FTX was largely possible due to two key organizational weakness and failures. One, FTX co-mingled customer funds with its institutional and proprietary funds, and two, FTX diverted significant portions of its customer deposits to its subsidiary, Alameda Research. This resulted in a systemic lack of adequate reserves to back its customer balances.
“The FTX fiasco was a direct result of mismanagement and grossly unethical decision-making, leading to significant fraud and loss of investor funds. Americans deserve better assurances regarding their deposits and the solvency of these platforms,” Tillis said. “The PROOF Act would improve regulation of the cryptocurrency industry by explicitly prohibiting the co-mingling of funds, while also setting a strong transparency standard with the already-used industry best practice of PoR. Combined, these two steps will help build trust that investors, both institutional and retail, can engage in digital asset markets.”
PoR is an already-existing industry best practice that is used to verify whether an institution holds sufficient reserves to back its customer balances.
Under the PROOF Act, the results of monthly PoR inspections are submitted to the U.S. Department of the Treasury, which is required to post the information publicly. The bill states that failure to submit to this inspection would result in a civil fine, derived through a tiered system that increases penalties for repeat offenders.
“FTX’s collapse made one thing clear: lack of customer protections in crypto will leave consumers in the lurch,” Hickenlooper said. “These commonsense safeguards make crypto companies more transparent and hold them to the same standards as everyone else.”
The bill has drawn praise from several industry firms, including Galaxy, Proven, and Castle Island Ventures.
“The PROOF Act standardizes solvency reporting requirements for digital asset exchanges and custodians in a way that will significantly improve consumer safety. Proof of Reserves (PoR) is an industry best practice that combines the cryptographic nature of digital assets with strong traditional audit standards to achieve greater industry transparency than is possible in traditional finance. Creating a framework that standardizes how digital assets firms indisputably prove the soundness of their platforms is overdue and will help investors, consumers, and even regulators identify and avoid the blowups that rocked the industry last year,” Alex Thorn, head of firmwide research at Galaxy, said.