Last year's revelations about fraud, money laundering, lies and deception by FTX, Binance and others have shaken public trust in the digital asset industry, and in particular its trading platforms. A strong commitment to transparency and investor protection is essential to regaining that trust.
Bruce Tupper is the President and Founder of CoinRegTech, which provides compliance services to the digital asset market. Tyler Williams is Head of Regulatory and Legislative Affairs and Regulatory Counsel at Galaxy, a financial services and investment management innovator in the digital asset and blockchain technology space.
We believe in two propositions – Reserve proof report and off-chain transaction reporting – are sensible requirements for trading platforms to implement. Both proposals would immediately increase transparency to protect customer funds. We need more, 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 worth noting. beginning, S.3087The PROOF Act, introduced by Sen. Thom Tillis (R-NC) and Sen. John Hickenlooper (D-CO) in October 2023, would require trading platforms to Every month, you will be required to cryptographically prove that you can comply with your deposits.
Number 2, HR5966, the Off-Chain Digital Commodity Transactions Reporting Act, also introduced by Rep. Don Beyer (D-VA) in October 2023, would require trading platforms to report all digital commodity transactions (such as Bitcoin and Ether). Mandating it would improve transparency and customer protection. ) to a trading repository licensed by the Commodity Futures Trading Commission (CFTC). This reporting requirement is comparable to what applies to swap transactions today.
These legislative initiatives are novel in that they take advantage of blockchain technology's remarkable public transparency and auditability features. Blockchain tracks debits and credits to accounts on a ledger, similar to a regular accounting system, but in a real-time, transparent, and immutable manner. The existence of any asset that resides on a public blockchain, whether a tokenized security or a digital product, is verifiable by customers and regulators. This does not apply to off-chain transactions that do not commit digital asset transactions to the appropriate blockchain. Instead, records of off-chain transactions are stored on the trading platform's internal systems and are not recorded on the blockchain. As a result, customers rely on the internal recordkeeping of unregistered trading platforms to track ownership records.
Currently, trading platforms and lawmakers are uniting around a simple idea: What if a trading platform acting as a custodian could prove its control of customer assets beyond a shadow of a doubt? This is known as proof of reserve (PoR). This evolving concept has existed in the digital asset market for about a decade. A PoR includes a trading platform that acts as a custodian that proves customer assets by committing all of them to a public ledge (on-chain). Publishing these datasets allows customers and regulators to verify assets and ensure that trading platforms are sound.
The legislative action focuses on requiring trading platforms to segregate customer assets from the trading platform's operating funds. The goal is to protect customers' assets while providing assurance to customers and regulators in the event of a trading platform's liquidation or bankruptcy. Some trading platforms voluntarily adopt monthly PoR certification. A PoR should be part of a comprehensive legislative solution adopted by the U.S. Congress, which is exactly what Sens. Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-Wyo.) New York) recognized this when it reintroduced the Lummis Gillibrand Responsible Finance Innovation Act. S.2281This included specific provisions requiring crypto intermediaries to maintain PoR and undergo annual verification. If blockchain technology is widely adopted across the financial services industry, it will increase transparency and reduce costs in markets and financial services.
Another “must” is Rep. Bayer's proposal (HR 5966) that would require trading platforms to report off-chain and on-chain trades to the CFTC trade repository, which the CFTC already collects on the swaps market. and how they are supervised. While on-chain transactions are already recorded on their respective blockchains, this bill would standardize and collect that data along with off-chain transactions, providing customers with transparency and trust in trading platforms and the digital asset market in general. . The Bayer bill would allow registered trade repositories to share trade data with the CFTC and the Securities and Exchange Commission. Reporting requirements would also help regulators monitor trading platforms and other market participants.
Some lawmakers in Washington have a very negative view of these transparency proposals. In some cases, lawmakers have attempted to disrupt the digital asset industry by blocking access to accounting services.in January letter Lawmakers attacked PoR against the Public Company Accounting Oversight Board (PCAOB), calling it a “sham audit.” The PCAOB has officially released it. recommendation letter Warning investors about PoR certification. As a result, audit firms are withdrawing from auditing, and the PCAOB's position is the opposite of what any reasonable accounting regulator should take.
The main criticism of PoR is primarily addressed in S. 3087 the Proof Act. PoR is not considered as a replacement for standard auditing, but rather as a complement to standard auditing practices. While traditional audit assurance is necessary, it is no substitute for high-frequency, publicly verifiable evidence that a customer’s funds reside on a trading platform that also acts as a custodian.
Trading platforms should not be held to different standards than traditional custodians or registered exchanges. Frequent PoR certifications could provide greater transparency than traditional custodians currently offer. Reporting both on-chain and off-chain digital asset transactions to a CFTC-registered transaction repository is a type of “trust but verify” approach, providing an additional layer of federal oversight and customer protection. To do.
The digital asset industry is promoting an honest and rational approach in the form of PoR and off-chain transaction reporting. You may need more. We just ask that politicians and regulators in Washington work with us. The digital asset industry is turning the page and working hard to regain the trust that customers and policymakers have lost.
With the advancement of the PoR bill and off-chain bill related to the Comprehensive Digital Assets Act, trading platforms and blockchain technology will have the opportunity to flourish and support a new era of American-led financial innovation and exceptionalism. This is a worthy goal, and one that Washington, D.C., should support.
