In a bid to address the vulnerabilities and risks within the cryptocurrency industry, US Senators Thom Tillis and John Hickenlooper have introduced the Proving Reserves of Others Funds (PROOF) Act, a bipartisan piece of legislation that promises to safeguard against unethical practices while introducing much-needed transparency.
The move comes in the wake of the high-profile collapse of FTX, which exposed systemic weaknesses in the industry.
Enhancing Investor Protection
The PROOF Act is designed to prevent a repeat of disasters like the FTX debacle, where mismanagement and unethical decision-making led to significant fraud and loss of investor funds.
The bill introduces strong safeguards to protect customer funds, thus ensuring that investors have better assurances regarding their deposits and the solvency of cryptocurrency platforms.
The legislation builds upon an already-existing industry best practice known as Proof of Reserves (PoR). Under the PROOF Act, digital asset institutions are mandated to undergo a monthly PoR inspection conducted by a neutral third-party auditing firm. This inspection serves to verify whether the institution holds sufficient reserves to back its customer balances, thereby enhancing investor protection.
Read: Why CEXs Need Merkle Tree Proof-of-Reserves
Transparency and Accountability
Monthly PoR inspections submitted to the US Department of the Treasury will be made publicly available, ensuring that the operations of digital asset institutions are subjected to greater scrutiny. Non-compliance with these inspections will result in civil fines, with penalties that escalate for repeat offenders, thus creating a strong incentive for adherence.
This is a welcome step towards bolstering investor confidence in the cryptocurrency industry and seen as a response to the systemic lack of adequate reserves, which contributed to the FTX collapse, and serves to prevent covert insolvencies. It also helps prevent practices such as co-mingling of customer funds, a problem that FTX suffered from.
Read: Republican Lawmakers Call for Clarity On Biden’s Crypto Regulations
Industry Support
The bill has received support from industry leaders and advocates.
Alex Thorn, Head of Firmwide Research at Galaxy Digital, emphasized the importance of this legislation for consumer safety and regulatory compliance. Thorn noted that PoR has emerged as a practical and effective measure to promote transparency within the industry, which traditional finance struggles to achieve. He believes that the PROOF Act is a significant step toward addressing the issues that have plagued the cryptocurrency industry.
Nic Carter, General Partner at Castle Island Ventures, welcomed the bill for acknowledging the industry-led self-regulatory efforts to enhance consumer protection and transparency in the digital asset space. He pointed out that the cryptographic properties of digital assets make the kind of transparency and accountability introduced by the act uniquely possible.
Lastly, Rich Dewey of Proven expressed that the bill provides everyday users of digital assets in the US with peace of mind by banning the co-mingling of assets and requiring PoR.
Read: New York Unveils Rigorous Cryptocurrency Listing Regulations
Final Thoughts – A Response to Industry Weaknesses
The PROOF Act aims to rectify the dual weaknesses that led to the FTX disaster: co-mingling of customer funds with institutional and proprietary funds, and the diversion of customer deposits to subsidiary entities. By establishing concrete customer protections and transparency requirements, the legislation creates a framework to better protect consumers and prevent future financial crises within the cryptocurrency sector.
In a space that has often been criticized for its lack of regulation and consumer protection, the bill is a significant step toward establishing standards and safeguards that will help the industry mature while providing investors with a higher degree of confidence. The bipartisan support for this legislation reflects a growing recognition within the US Senate of the need to address issues within the cryptocurrency space and bring it in line with more traditional financial systems.