PROOF Act Targeting Crypto Industry Risks, Focusing on Safe Handling and Openness with Customer Money

Following FTX's failure, U.S. Senators Thom Tillis and John Hickenlooper have reintroduced the PROOF Act. This bill targets crypto industry risks

Following the high-profile failure of FTX, which involved the mixing of customer and company funds, Senators Thom Tillis and John Hickenlooper have once again introduced the ‘Proving Reserves of Other Peoples’ Funds (PROOF) Act.’

This legislation, which was initially unveiled in 2023, aims to mitigate specific risks within the cryptocurrency industry by focusing on the safe handling of customer money and promoting openness with investors.

The PROOF Act, which was first introduced by @SenThomTillis and @SenatorHick in 2023, would ban crypto custodians from co-mingling customer funds and require them to comply with monthly reserve inspections.

The bill is designed to help prevent another FTX situation.

What Does the PROOF Act Require? No Fund Mixing, Monthly Reserve Checks

The PROOF Act sets out to establish clear regulations for digital asset institutions in managing customer funds. A key focus is on the co-mingling of customer funds with institutional or proprietary assets.

This practice, which was a factor in FTX’s failure, used to allow crypto firms to misuse customer deposits for their own purposes, posing significant risks to investors. By forbidding this practice and placing the onus on institutions to comply with monthly Proof of Reserves (PoR) inspections, the bill aims to create a safer investing climate.

These audits will be conducted by independent auditors, who will also be tasked with confirming the results and submitting them to the US Treasury for subsequent public release. This will make it easier for investors to verify that exchanges and custodians have the necessary assets to meet their obligations.

Institutions found in violation of these regulations will face administrative fines, with penalties increasing for repeat offenders.

How PoR Contributes to Safer Customer Funds

Proof of Reserves, a technology used in crypto to ensure transparency in a firm’s financial standing, is at the heart of this legislation.

It leverages crypto’s capabilities to allow exchanges and custodians to demonstrate that they hold sufficient assets to cover the balances reported in their customers’ accounts.

This can be achieved through various methods, including Merkle trees or zero-knowledge proofs, which are already employed in the crypto industry for different use cases. The PROOF Act aims to standardize these procedures and ensure the audits are conducted by credible third parties, ultimately enhancing the reliability of the information being provided.

Can Mandatory PoR Audits and Clear Rules Build Crypto Investor Trust?

The bill also touches upon the broader need for clear rules and standards in an industry that has lacked consistent oversight, especially as institutions navigate the complexities of new technologies and financial instruments.

With institutions required to undergo regular PoR checks and the results being placed in the public domain, the PROOF Act focuses on digital asset institutions being held directly accountable to the public. This approach will be integral in establishing greater transparency.