Revelations
last
year
involving
fraud,
money
laundering,
lies
and
deception
by
FTX,
Binance
and
others
have
shaken
the
public’s
trust
in
the
digital
assets
industry
–
especially
its
trading
platforms.
Transparency
and
a
strong
commitment
to
investor
protection
are
vital
to
earning
back
that
trust.
Bruce
Tupper
is
the
president
and
founder
of
CoinRegTech,
which
provides
compliance
services
to
the
digital
asset
market.
Tyler
Williams
is
the
head
of
regulatory
and
legislative
affairs
and
regulatory
counsel
for
Galaxy,
a
financial
services
and
investment
management
innovator
in
the
digital
asset
and
blockchain
technology
sectors.
We
believe
two
proposals
–
Proof
of
Reserves
Reporting
and
Off-Chain
Transaction
Reporting
–
are
prudent
requirements
for
trading
platforms
to
implement.
Both
proposals
would
immediately
improve
transparency
to
protect
customer
funds.
More
is
necessary,
but
let’s
not
let
the
perfect
be
the
enemy
of
the
good.
It
is
past
time
for
the
U.S.
Congress
to
move
forward
with
comprehensive
digital
asset
legislation.
Two
recent
bills
are
noteworthy.
First,
S.
3087,
The
PROOF
Act,
introduced
by
Senators
Thom
Tillis
(R-NC)
and
John
Hickenlooper
(D-CO)
in
October
2023,
would
require
trading
platforms
to
cryptographically
prove
monthly
that
they
can
honor
all
customer
deposits
held
in
custody.
Second,
H.R.
5966,
the
Off-Chain
Digital
Commodity
Transaction
Reporting
Act,
introduced
by
Rep.
Don
Beyer
(D-VA),
also
in
October
2023,
would
improve
transparency
and
customer
protection
by
requiring
trading
platforms
to
report
all
digital
commodity
transactions
(such
as
Bitcoin
and
Ether)
to
a
trade
repository
licensed
by
the
Commodity
Futures
Trading
Commission
(CFTC).
This
reporting
requirement
is
comparable
to
what
applies
to
swaps
transactions
today.
These
legislative
efforts
are
novel
in
using
blockchain
technology’s
noteworthy
public
transparency
and
auditability
functionality.
Blockchains
track
debits
and
credits
to
accounts
on
a
ledger,
just
like
an
ordinary
accounting
system,
but
in
a
real-time,
transparent,
and
immutable
fashion.
The
existence
of
any
asset
that
resides
on
a
public
blockchain,
whether
a
tokenized
security
or
a
digital
commodity,
is
verifiable
by
customers
and
regulators.
This
is
not
the
case
for
off-chain
transactions,
which
don’t
commit
digital
asset
transactions
to
the
appropriate
blockchain.
Instead,
records
of
off-chain
transactions
are
stored
in
the
trading
platform’s
internal
systems
and
not
recorded
on
the
blockchain.
As
a
result,
customers
rely
on
the
internal
recordkeeping
of
unregistered
trading
platforms
to
track
their
record
of
ownership.
Now,
trading
platforms
and
lawmakers
are
coalescing
around
a
simple
idea:
What
if
trading
platforms
that
act
as
custodians
could
indisputably
prove
control
over
customer
assets?
This
is
known
as
a
Proof
of
Reserve
(PoR).
This
evolving
concept
has
existed
in
the
digital
asset
markets
for
about
a
decade.
PoR
involves
a
trading
platform
acting
as
a
custodian
to
attest
to
their
customer
assets
by
committing
all
these
assets
to
a
public
ledge
(on-chain).
By
publishing
these
datasets,
customers
and
regulators
could
verify
assets,
and
assure
trading
platforms
are
sound.
Legislative
initiatives
have
focused
on
mandating
trading
platforms
to
segregate
client
assets
from
the
operational
funds
of
trading
platforms.
The
goal
is
to
provide
customers
and
regulators
with
assurances
in
the
case
of
a
trading
platform
liquidation
or
bankruptcy
while
protecting
customer
assets.
Some
trading
platforms
have
voluntarily
adopted
monthly
PoR
attestations.
PoR
should
be
part
of
any
comprehensive
legislative
solution
adopted
by
the
US
Congress,
which
is
precisely
what
Senators
Cynthia
Lummis
(R-WY)
and
Kirsten
Gillibrand
(D-NY)
recognized
when
they
reintroduced
the
Lummis-Gillibrand
Responsible
Financial
Innovation
Act,
S.
2281,
which
included
a
specific
provision
that
would
require
crypto
intermediaries
to
maintain
PoR
and
undergo
annual
verifications.
If
blockchain
technology
were
broadly
implemented
across
our
financial
services
industry,
markets
and
financial
services
would
be
more
transparent
and
less
costly.
The
other
“must
have”
is
Rep.
Beyer’s
proposal
(HR
5966)
requiring
trading
platforms
to
report
off-chain
and
on-chain
transactions
to
a
CFTC
trade
repository,
similar
to
how
the
agency
already
collects
and
oversees
swaps
markets.
While
on-chain
transactions
are
already
recorded
on
their
respective
blockchains,
this
bill
would
standardize
and
gather
that
data,
along
with
off-chain
transactions,
to
offer
customers
transparency
and
confidence
in
trading
platforms
and
the
digital
asset
market
generally.
The
Beyer
bill
would
permit
a
registered
trade
repository
to
share
transaction
data
with
the
CFTC
and
the
Securities
and
Exchange
Commission.
The
reporting
requirement
would
also
assist
regulators
in
monitoring
the
trading
platforms
and
other
market
participants.
Some
lawmakers
in
Washington
have
taken
a
very
negative
view
of
these
transparency
proposals.
In
some
cases,
lawmakers
have
sought
to
stymie
the
digital
asset
industry
by
blocking
access
to
accounting
services.
In
a
January
letter
to
the
Public
Company
Accounting
Oversight
Board
(PCAOB),
lawmakers
attacked
PoR
and
called
it
a
“sham
audit.”
The
PCAOB
duly
released
an
advisory
letter
warning
investors
about
PoR
attestations.
As
a
result,
audit
firms
have
pulled
back
from
engagements,
and
the
PCAOB’s
stance
is
the
opposite
of
what
a
reasonable
accounting
regulator
should
do.
The
major
criticisms
of
PoR
have
largely
been
addressed
in
S.
3087
the
Proof
Act.
PoR
is
not
contemplated
as
a
substitute
for
standard
audits,
but
rather
to
complement
standard
audit
practices.
Traditional
audit
assurance
is
necessary,
but
it
is
no
substitute
for
high-frequency
and
publicly
verifiable
proof
that
customer
funds
are
present
with
the
trading
platform
that
is
also
acting
as
a
custodian.
Trading
platforms
shouldn’t
be
held
to
a
different
standard
from
traditional
custodians
and
registered
exchanges.
Frequent
PoR
attestations
could
provide
more
transparency
than
traditional
custodians
currently
offer.
The
reporting
of
both
on-chain
and
off-chain
digital
asset
transactions
to
a
CFTC-registered
trade
repository
–
a
kind
of
“trust,
but
verify”
approach
–
offers
an
additional
layer
of
federal
oversight
and
protection
for
customers.
The
digital
asset
industry
is
putting
forward
good
faith
and
reasonable
approaches
in
the
form
of
PoR
and
Off-Chain
Transaction
Reporting.
More
may
be
necessary.
We
ask
simply
that
Washington
politicians
and
regulators
work
with
us.
The
Digital
Asset
industry
is
turning
a
page
and
working
hard
to
gain
back
the
trust
lost
by
customers
and
policymakers.
With
the
advancement
of
the
PoR
and
Off-Chain
bills
in
connection
with
comprehensive
digital
asset
legislation,
trading
platforms
and
blockchain
technology
will
have
the
opportunity
to
flourish
and
underpin
a
new
era
of
American-led
financial
innovation
and
exceptionalism.
This
is
a
worthy
goal
and
one
that
Washington
D.C.
should
support.
