PROOF Act: US senators introduce bipartisan proof of reserves bill

U.S. Senators Thom Tillis (R-NC) and John Hickenlooper (D-CO) introduced the Proving Reserves of Others Funds (PROOF) Act on October 20, a bipartisan bill that would establish protections against “unethical co-mingling of customer funds” while also requiring digital assets institutions to submit to a monthly proof of reserves (PoR) inspection by a neutral third-party auditing firm.

Should it eventually pass into law, the senators hope the bill could help prevent another
FTX-style disaster and the resulting losses to consumer funds.

“The FTX fiasco was a direct result of mismanagement and grossly unethical decision-making, leading to significant fraud and loss of investor funds,” said Senator Tillis. “Americans deserve better assurances regarding their deposits and the solvency of these platforms.”

Tillis suggested that the PROOF Act would improve regulation of the digital asset 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.”

PoR is used to verify whether an institution holds sufficient reserves to back its customer balances. It’s a hot topic in the digital asset space, particularly concerning so-called stablecoins, which are supposed to always be backed 1:1 by the related fiat or other equally liquid assets.

The implosion of FTX was partly down to the company propping up huge speculative losses, made with customer funds, with its native token, FTT. When the value of FTT plummeted in late 2022, the hole in FTX’s reserves was revealed, and the company spiraled into bankruptcy.

Under the PROOF Act, the results of monthly PoR inspections would be submitted to the U.S. Department of the Treasury, which would then be required to post the information publicly. Failure to submit to the inspection would result in a civil fine and increased penalties for repeat offenders.

“These commonsense safeguards make crypto companies more transparent and hold them to the same standards as everyone else,” said Hickenlooper. “FTX’s collapse made one thing clear: lack of customer protections in crypto will leave consumers in the lurch.”

What exactly does it do?

Senators Tillis and Hickenlooper stated the FTX implosion revealed two key operational failures: the co-mingling of customer funds with institutional and proprietary funds, and FTX diverting customer deposits to its subsidiary, Alameda Research, resulting in a lack of adequate reserves.

The Proof Act seeks to address these by establishing “clear and concrete customer protections, while also creating an important mechanism to provide greater transparency into digital asset exchange and custodial operations.”

Specifically, the legislation would:

(1) Establish regulatory standards on how digital asset institutions can hold customer assets, including a prohibition of the co-mingling of customer funds;
(2) and require digital asset exchanges and custodians to submit to a PoR inspection by a neutral third party.

Industry support

The bill’s announcement was warmly received by certain finance and digital asset sector players.

Bryan Daugherty, Public Affairs Director – Americas of the BSV Blockchain Association, describes the PROOF Act as “the groundwork for enhanced digital financial security” that needs the integration of blockchain technology to propel the industry “into an era of unparalleled transparency, immediacy, and trustworthiness.” He explains:

“The PROOF Act stands as a testament to our collective commitment to fortify consumer and investor protections within the digital asset realm. Anchored by its uncompromising stance against the unethical mingling of funds, this Act is a direct response to prevent catastrophes akin to the FTX debacle from reoccurring.

“While the Act’s mandate for monthly PoR inspections by impartial third-party auditors is laudable, we must recognize that as the digital economy burgeons, our protective mechanisms need to not just adapt but leap ahead. Enter the transformative power of blockchain. This technology transcends the time-tested double-entry accounting model by introducing a pioneering Triple Entry Accounting System. Beyond the customary two entries, blockchain integrates a third entry—a cryptographic seal, ensuring that every transaction isn’t just genuine, but also indelible.

“This isn’t merely a step forward in technology—it’s a seismic shift in our approach to financial transparency. Empowered by blockchain’s crystal-clear framework, regulators are now armed with the prowess of Real-time Oversight. Gone are the days where fraud detection was a reactive process, laden with delays and potential financial harm. Today, with the immediacy blockchain offers, illicit activities can be pinpointed and curtailed in the blink of an eye.

“Moreover, the inherent Immutability of blockchain emerges as the ultimate safeguard against deceptive alterations. Once a transaction is inscribed onto the blockchain, it is set in stone—unalterable and eternal. This permanence not only acts as a deterrent to malevolent acts but guarantees that every fraudulent attempt remains indelibly marked, rendering concealment efforts futile.”

For Rich Dewey, founder and CEO of tech startup Proven, “The PROOF Act is exactly what users of digital assets need in the US. By banning the comingling of assets and requiring PoR, everyday users will be able to use crypto with peace of mind.”

Alex Thorn, Head of Firmwide Research at Galaxy, echoed this sentiment. “The PROOF Act standardizes solvency reporting requirements for digital asset exchanges and custodians in a way that will significantly improve consumer safety,” Thorn said.

“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.”

Another voice in support was Nic Carter, General Partner at Castle Island Ventures, who praised the bill for ensuring “that digital asset platforms cannot comingle client and operating capital.”

“The PROOF Act ensures that another covert insolvency like FTX, Quadriga, or Mt Gox can never again occur,” said Carter.

The bill will now pass to the committee, where a debate and vote will decide whether it proceeds to a full Senate vote.

Watch: SEC Commissioner Hester Peirce on Blockchain Policy Matters