Embracing Self-Regulation: The Crypto Industry Sets the Stage, Is It Time for Washington to Follow Suit?

**Public Blockchains: Revolutionizing Accounting with Proof of Reserve**

**Introduction**

Public blockchains have garnered significant attention and hype over the past decade, with promises of revolutionizing various domains, from securities settlement to social media. While these benefits may eventually materialize, one area where blockchains are undeniably surpassing traditional systems today is accounting. Blockchains offer real-time, transparent, and immutable tracking of debits and credits, providing a level of auditability that traditional systems lack.

**The Auditability Advantage**

Unlike traditional assets or commodities that rely on intermediaries to verify their existence, digital assets on blockchains can be fully verified by anyone with an internet connection. Whether it’s a tokenized security or a digital commodity like Bitcoin, the existence of these assets can be verified at any time. Additionally, cryptographic signatures allow entities to mathematically prove ownership of digital assets without the need for intermediaries.

This high level of auditability has empowered crypto platforms to build attestation tools that enable users to verify the reserves held by exchanges and custodians. These tools address the long-standing issue of trust in the crypto industry, which has been marred by a series of failures and losses. By providing proof of reserves, platforms can assure users that their assets are genuinely held in reserve and not simply entries on a ledger prone to error or fraud.

**The Need for Proof of Reserve**

Exchanges and custodial platforms are now realizing the significance of providing indisputable proof that they control the funds held for users. This concept, known as proof of reserve (PoR), involves platforms providing signatures attesting to their ownership of specific digital assets on-chain, along with a disclosure of client liabilities. By publishing these datasets and allowing verification, platforms can offer strong assurances to users regarding the soundness of their operations.

**The Role of Legislation and Industry Adoption**

Legislative initiatives at the state and federal levels have recognized the importance of PoR. For example, Texas passed a landmark bill that requires firms with money transmitter licenses to conduct PoRs starting in September. Many large exchanges globally, such as Kraken, Binance, and Bitmex, have voluntarily adopted PoR, covering billions of dollars in client assets.

Regulators in Wyoming, Dubai, Singapore, Canada, and Bermuda have also acknowledged the significance of PoR in their frameworks and guidance. However, PoR still faces criticism from lawmakers such as Sens. Elizabeth Warren and Ron Wyden, who have targeted auditors servicing crypto firms. This opposition threatens to undermine the industry’s effort to improve transparency and accountability.

**Addressing Criticisms and Advancing PoR**

Addressing common criticisms of PoR is essential in gaining broader acceptance and standardization. PoR should not be seen as a substitute for conventional audits but as a complementary form of assurance. Texas legislation, for instance, incorporates both PoRs and the involvement of certified public accountants (CPAs) to supervise the process. Specialist CPA firms have emerged with expertise in overseeing these procedures.

Furthermore, innovations such as zero-knowledge proofs ensure the safe execution of PoRs without compromising client data. PoR should not hold crypto exchanges to a different standard than traditional custodians, but rather provide a higher level of transparency and assurance. The goal is to enhance conventional audits with frequent PoR attestations to provide a level of assurance unattainable with traditional assets.

**Proposing Supportive Actions from Washington**

To foster the adoption and standardization of PoR, Washington should cease undermining the industry’s self-improvement efforts. Lawmakers should recognize the validity of PoR and facilitate its proliferation across the industry. Encouraging accounting standards-setting bodies like the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB) to ratify industry efforts is crucial for audit firms to feel empowered in supervising PoRs.

Washington should also acknowledge the positive efforts already made by custodians to enhance transparency and accountability. By supporting the widespread adoption and standardization of PoR, the crypto industry can surpass the level of assurance offered by traditional custodians, ultimately regaining trust.

**Conclusion**

Public blockchains excel in accounting due to their ability to provide real-time, transparent, and immutable tracking of debits and credits. Proof of reserve (PoR) plays a vital role in addressing trust issues in the crypto industry, allowing users to verify that their assets are genuinely held in reserve. Legislative initiatives and industry adoption of PoR reflect its significance, while criticisms must be addressed to advance its acceptance and standardization. Washington should support the crypto industry’s efforts to improve transparency and accountability by recognizing the validity of PoR and facilitating its proliferation.