Senators Reintroduce PROOF Act to Prevent Fund Mixing by Digital Asset Custodians

US Senators Thom Tillis and John Hickenlooper have reintroduced a legislative measure aimed at preventing digital asset custodians from mixing customer funds with institutional or proprietary capital. The bill, known as the Proving Reserves of Others Funds (PROOF) Act, also mandates monthly third-party inspections of custodial reserves, aligning with standards already informally used in the digital asset sector.

The PROOF Act was initially introduced in 2023 as a response to the systemic failures revealed by the collapse of the crypto exchange FTX. The legislation highlights that FTX's downfall was driven by two key operational flaws: the co-mingling of customer assets with corporate funds and the diversion of customer deposits to Alameda Research, a related entity. These practices led to a critical reserve shortfall, resulting in losses of over $8 billion for users when the platform failed.

The PROOF Act proposes two main requirements for digital asset exchanges and custodians. Firstly, it would establish regulatory standards that explicitly prohibit the mixing of customer and institutional funds. Secondly, it would require these platforms to undergo monthly Proof of Reserves (PoR) inspections conducted by a neutral third party, preferably a certified auditing firm. The results of each PoR inspection would be submitted to the US Department of the Treasury, which would be responsible for publicly disclosing the findings. Entities that fail to comply would face civil penalties under a tiered enforcement structure, with repeat violations triggering escalated consequences.

The bill defines PoR as a cryptographic method that enables exchanges and custodians to verify asset backing for user deposits. Techniques such as Merkle trees or zero-knowledge proofs allow these entities to demonstrate reserve holdings without disclosing sensitive information. The process is designed to maintain transparency while respecting the privacy and security of the platform and its users.

Although several crypto firms have voluntarily published reserve attestations since the FTX collapse, the PROOF Act addresses gaps in standardization and oversight. The bill notes that many prior implementations were inconsistent and lacked certified public accountant (CPA) validation. Tillis and Hickenlooper’s proposal seeks to move the practice from voluntary to mandatory, requiring uniform reserve verification across platforms that custody digital assets. The legislation emphasizes that American users of crypto exchanges deserve clear assurances about the solvency of custodial institutions holding their deposits.

While the PROOF Act aims to enhance transparency and security in the digital asset sector, it remains to be seen how the legislation will be received by industry stakeholders and whether it will gain sufficient support to become law. The bill's reintroduction comes at a time when regulatory scrutiny of the crypto industry is increasing, and lawmakers are seeking to address the risks and vulnerabilities exposed by high-profile collapses like FTX.