Tillis bill strengthens customer protections in digital asset markets

In the wake of the collapse of cryptocurrency exchange FTX, U.S. Sen. Thom Tillis (R-NC) recently introduced legislation that would provide American customers of digital asset platforms better protections and improve transparency by prohibiting the co-mingling of industry funds. 

“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,” Sen. Tillis said on Oct. 19. 

The bipartisan Proving Reserves of Others Funds (PROOF) Act, S. 3087, sponsored by Sen. Tillis and cosponsored by U.S. Sen. John Hickenlooper (D-CO), would establish clear customer protections while creating a framework to provide greater transparency into digital asset exchange and custodial operations. 

The failure of FTX was largely due to two main weaknesses, Sen. Tillis’ office explained. FTX co-mingled customer funds with its institutional and proprietary funds, and FTX diverted a large amount of customer deposits to its subsidiary, which led to a lack of adequate reserves to support its customer balances.

The PROOF Act would address those issues by establishing regulatory standards on how digital asset institutions can hold customer assets, including a prohibition of the co-mingling of customer funds, and by requiring digital asset exchanges and custodians to submit to a Proof of Reserves (PoR) inspection by a neutral third-party, according to a summary of the bill. PoR is a practice already utilized to verify whether an institution holds sufficient reserves to back its customer balances.

“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,” Tillis said.

The PROOF Act would require that the results of monthly PoR inspections be submitted to the U.S. Treasury Department and made public. Failure to submit to that inspection would result in a civil fine where penalties would increase for repeat offenders. 

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