Proposed SEC Rules Would Apply Custody Rules To Crypto

Proposed SEC Rules Would Apply Custody Rules to Crypto

On Wednesday, the Securities and Exchange Commission (SEC) proposed sweeping new changes to federal custody regulations to include crypto assets and will require crypto firms to apply or maintain registration with the agency in order to hold customer funds. 

The changes came into being due to recent failures by crypto platforms to protect customer funds from potential cyberattacks and insolvencies. The financial regulator argued that as more retail investors got into cryptocurrencies, it was more than necessary to bring the assets under its watch.

The SEC pointed out that recent unfaithful behaviour from crypto firms like FTX and Celsius could potentially destabilise the economy if left unchecked. Both companies filed for Chapter 11 bankruptcy protection last year after facing liquidity crunches due to financial mismanagement and locked up customer assets after insolvency. 

Proposed SEC Rules Would Apply Custody Rules to Crypto

Current federal regulations are applicable to assets like funds or securities that require investment advisors such as asset managers or brokerages (Fidelity or BlackRock) to hold those assets with a federal or state-chartered bank. However, when it comes to cryptocurrencies, some federal regulators discourage custodians like banks from holding customer funds deposited on crypto exchanges, like Coinbase or Binance. 

New Rules Of The SEC

Under the new rules proposed by the SEC, any entity that wishes to custody clients’ crypto assets will have to hold federal charters, qualify as a registered broker, or futures commission merchant, or be an established trust or foreign financial institution. The requirements to become a qualified custodian will not be changed in the new proposal and crypto firms will be allowed to serve as such once registered with the SEC. 

What’s also required in the amended regulation will be a written agreement between custodians and advisors. The new law will expand the “surprise examination” requirements and enhance recordkeeping rules. SEC Chairman Gary Gensler stated that the current 2009 rule covers a “significant amount” of crypto assets.

Under the new rule, most cryptocurrencies are likely to be considered funds or securities covered by the existing regulation. Gensler also noted that although some crypto trading and lending platforms claim to be custodians of investors’ crypto, they do not qualify as such. 

New Rules Of The SEC

The SEC chair pointed to the recent collapses of some high-profile crypto firms where investors’ assets oftentimes became the entity’s property after they went bankrupt, leaving customers at the mercy of bankruptcy courts.

According to a statement released by the agency on Wednesday, the proposed changes will ensure that “client assets are properly segregated and held in accounts designed to protect the assets in the case of bankruptcy or another insolvency by a qualified custodian”. 

In an interview given to Bloomberg, Paul Grewal, Chief Legal Officer of crypto exchange Coinbase, stated that the company is already in line with the proposed regulatory changes and is a role model to other crypto trading and lending platforms. Grewal also commended the SEC on its latest proposal. In its earnings report, the U.S-based crypto exchange explained that it keeps customer assets “bankruptcy remote” from its creditors, but mentioned that the “novelty” of cryptocurrencies meant it was unclear how regulators would treat them. 

Recently, the SEC has been targeting revenue models of crypto institutions. Just last week, the regulator settled a lawsuit with crypto exchange Kraken for $30 million over its crypto staking program. SEC argued that the service constituted the offering and sale of unregistered securities. At the time, Coinbase CEO Brian Armstrong commented that a potential move by financial regulators against crypto-staking services would be a “terrible path” for investors. 

The SEC is also taking regulatory action against stablecoins, cryptocurrencies backed 1:1 with USD to maintain a constant value of $1, and looking into the asset class’ reserve backing. Earlier this month, the financial watchdog filed a lawsuit against Paxos Trust Co. regarding the issuance of BUSD stablecoins. The company was ordered to stop minting the token which is the world’s third-largest stablecoin and the most traded asset on the cryptocurrency exchange Binance. SEC is also investigating the reserves of USDC stablecoin which is issued and distributed by Circle, a company backed by Coinbase. 

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