U.S. Senators Thom Tillis (R-NC) and John Hickenlooper (D-CO) have reintroduced a legislative initiative aimed at preventing digital asset custodians from mixing customer funds with institutional or proprietary resources.
Known as the Proving Reserves of Others Funds (PROOF) Act, the bill also requires monthly inspections of custodial reserves by third parties, enhancing standards that are already informally applied within the digital asset arena.
Originally put forward in 2023, the PROOF Act emerged in response to the systemic risks unveiled by the FTX crypto exchange’s collapse.
As noted in the reintroduced legislation, FTX’s downfall can be attributed to two major operational problems: the blending of customer assets with corporate finances and the allocation of customer deposits to Alameda Research, a related firm.
Such practices resulted in a significant reserve deficit that left users unable to recoup their funds when the platform failed, leading to losses exceeding $8 billion.
Safeguard Provisions
The PROOF Act lays out two key obligations for digital asset custodians and exchanges. Firstly, it aims to set regulatory standards that outright ban the mixing of customer funds with institutional assets.
Secondly, it mandates that these platforms undergo monthly Proof of Reserves (PoR) evaluations carried out by an independent third-party, ideally a certified audit firm.
The bill stipulates that the outcomes of each PoR evaluation must be reported to the U.S. Department of the Treasury, which would be responsible for making the findings public.
Non-compliant entities would face civil penalties under a progressively increasing enforcement framework, with repeated violations leading to heightened repercussions.
The legislation defines PoR as a cryptographic technique that allows exchanges and custodians to validate the asset backing for user deposits. Methods like Merkle trees or zero-knowledge proofs enable these entities to verify reserve holdings without revealing sensitive details.
This process aims to promote transparency while ensuring the privacy and security of both the platform and its users.
A ‘Critical Step’
Despite many crypto firms voluntarily releasing reserve attestations following the FTX debacle, the PROOF Act seeks to fill gaps in standardization and regulation. The bill points out that numerous previous efforts were inconsistent and lacked validation from certified public accountants (CPAs).
The proposal by Tillis and Hickenlooper aims to shift these practices from voluntary participation to mandatory compliance, enforcing uniform reserve verification across digital asset custodial platforms. The legislation underscores that American users of crypto exchanges merit clear assurances regarding the financial stability of institutions safeguarding their deposits.
Chainlink expressed support for the bill’s reintroduction in a post on X, describing it as a “critical step toward implementing Proof of Reserve requirements for digital assets.”
The post further elaborated:
“As real-world assets continue to move onchain, legislation like the PROOF Act underscores the importance of Proof of Reserves and is vital for ensuring transparency in the digital asset sector.”