SEC Rule Change May Put Pressure on Crypto Platforms

The US Securities and Exchange Commission (SEC) has proposed new rules to regulate the custody of cryptocurrencies by investment advisers such as hedge funds and pension funds. The proposal would require such advisers to use qualified custodians to hold assets, and it would also create new requirements for qualified custodians. The rule expands the qualified-custodian requirements to include virtually any assets that an adviser might hold in a client's name, including all cryptocurrencies, and some physical assets like artwork. The proposal would limit how asset managers can handle customers' crypto assets, but it wouldn't impose new requirements on individual investors who manage their own portfolios. While traditional qualified custodians have typically been banks, trust companies, and broker-dealers, the idiosyncrasies of keeping assets like bitcoin safe from theft or hacks have led Coinbase Global and similar crypto platforms to start offering the service.

SEC Chair Gary Gensler has repeatedly expressed concerns that “crypto firms' custody practices might not clear the legal hurdles necessary to keep their customers' assets safe in the event of bankruptcy”. “The proposal would also limit how asset managers can handle customers' crypto assets, citing features of cryptocurrencies that could make them difficult to safeguard in compliance with the rules”. He noted that “investment advisers have already lost money in the bankruptcies of Celsius Network, Voyager Digital, and FTX because those firms commingled customer assets with their own”.

Coinbase to its customers

Coinbase has claimed that thousands of institutional customers use its Prime platform to safeguard their assets and that it is a qualified custodian. The firm reported $68.4 million in fees from its custodial services in the first nine months of 2022, down 21% from a year earlier.

Paul Grewal, Coinbase's chief legal officer, said the firm is confident that it's New York-chartered trust entity “will remain a qualified custodian.” In its SEC disclosures, Coinbase says that in the event of bankruptcy, customers whose crypto assets the firm custodies “could be treated as our general unsecured creditors.”

Hester Peirce, the only SEC commissioner to vote against the proposal, expressed concerns that the proposal could shrink the number of qualified custodians for crypto assets, leaving investors more vulnerable to theft or fraud.

The expectation of executives from the proposed change rules

Several custody-firm executives have said they expect the proposed rules would eventually add new requirements for what it means to be an authorized custodian. Some existing providers may opt not to remain in the business. They also said the SEC's proposal could encourage investment firms to entrust their crypto assets to mainstream banks, even as bank regulators scrutinize crypto activities.

The rule proposed on Wednesday would expand the qualified-custodian requirements to include virtually any assets that an adviser might hold in a client's name. Cryptocurrencies are often transferable by anyone who holds a “private key.” Because of that, the SEC's proposal says, it may be more difficult for a custodian to demonstrate that it has exclusive control of crypto than of traditional assets like stocks and bonds.

Republican SEC Commissioner Mark Uyeda said the proposal raises questions about whether an investment adviser looking to offer crypto could ever satisfy the regulatory requirements. “This approach to custody appears to mask a policy decision to block access to crypto as an asset class,” Uyeda said. Nevertheless, he praised the decision to advance crypto policy via rulemaking rather than enforcement actions and voted to support the proposal.

The proposal will be open to public comment for at least two months before staff begins work on a final rule.

In a separate move, SEC commissioners voted to adopt a new rule in response to the GameStop trading frenzy of early 2021. The rule requires Wall Street firms to reduce the time it takes to settle most securities trades to one business day from two, reducing the amount of collateral that brokerages must post at the stock market.

As a reminder, WikiBit is ready to help you search the qualifications and reputation of projects in a bid to protect you from hidden dangers in this risky industry!

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