A measure requiring proof of reserve was adopted by the Texas House of Representatives. This would necessitate cryptocurrency exchanges keeping reserves “in an amount sufficient to fulfil all obligations to customers” on April 20. The bill will now be sent to the Senate for consideration. If the measure passes the Senate and is signed by the governor, it may become law on September 1, 2023.
Proof-of-Reserves (PoR) is a verifiable auditing approach that answers to questions about transparency issues regarding the assets stored on exchanges. In other words, Proof-of-Reserves is a method of verifying that an organisation, such as a cryptocurrency exchange, has adequate reserves to back all customer balances. This solution overcomes issues about asset transparency on exchanges and assures that the crypto is backed by actual assets.
‘Merkle Tree’ is an anonymous proof of client balances which is used for Proof-of-Reserves. It allows every individual to cryptographically verify that the exchange retains their cash. They can also check that their account balances are included in the PoR. This method totals all client balances without disclosing any confidential information.
The bill makes changes to the Texas Finance Code, specifically Section 160. According to the amendments, digital asset providers that serve more than 500 customers in the state and have at least $10 million in customer funds would be prohibited from combining customer funds with any other type of operational capital. They are also prohibited from using customer funds for any other transactions other than the original transaction requested by the customer.
Furthermore, the provider would have to keep reserves large enough to cover any probable withdrawals promptly. It should also “create a plan” to allow auditors to evaluate the information made accessible to the customer.
Any exchange has to file a report with the State Banking Department on its outstanding liabilities to clients by the 90th day following the end of each fiscal year. The report should also include the auditor’s attestation as well. If the provider fails to meet the conditions, the Banking Department has the authority to cancel its licence.
PoRs have become quite a necessity after the 2022 market failure. FTX collapsed in November 2022 leading to losses of billions and the crypto market falling below a $1 trillion valuation. Later, the firm filed for bankruptcy.
Although the PoR approach ensures that a cryptocurrency corporation has sufficient assets to satisfy its liabilities, many experts do not see it as a flawless system. They argue that the system provides only a single depiction in time and does not provide a live accounting of balances over time. Furthermore, it simply displays the custodian’s on-chain assets and does not monitor where such assets come from.
