The SEC sets eyes on crypto custody - what this means for future custodians
The SEC (Securities and Exchange Commission) has recently proposed to expand the scope of regulations in order to include cryptocurrency and other digital assets into federal custody rules.
The amendments, if passed, would require crypto custody service providers or companies who hold client digital assets to maintain registration and to keep those assets segregated and held in accounts that would protect them from potential insolvency.
Sounds like a handful, but if we look closer at crypto custody and how it differs from simply “holding client assets” we’ll see that a qualified custodian would already be doing what the SEC suggests. But there’s more to their initiative.
It appears the SEC wishes to regulate crypto exchanges that provide custody services, in particular, clients with high net worth, such as hedge funds managers. This may have a large impact on crypto custody programs or fiat custodians like banks that choose to hold clients’ crypto assets. The amendments do not target crypto companies specifically, but SEC Chair Gary Gensler mentioned in a statement that “not all crypto platforms that claim to custody client assets are qualified custodians.”
This could mean tighter regulations are in the works. But for now, under the new rules, a company would have to qualify as a registered broker-dealer or futures commission merchant in order to hold client assets, including crypto custody. It’s also important to note that the SEC has yet to decide which cryptocurrencies it considers securities. For example, the SEC has recently attempted to claim the Paxos stablecoin was a security, resulting in an ongoing dispute with the firm.
The impact on crypto custodians
For now, only U.S based custodians are feeling the brunt of the SEC swings. Coinbase and Gemini, which are state-chartered trust companies, would be eligible to serve as qualified custodians under the proposed amendments.
The real impact here is how smaller crypto firms may not have the resources to meet the new regulatory requirements. This extends to institutions that want to expand into crypto custody and even global custodians who want to enter the US market. It may potentially limit the interaction between US clients and international companies.
The SEC’s proposed changes have, at best, drawn mixed reactions from industry stakeholders. At worst, some say the regulatory burden could stifle innovation and harm smaller companies.
One thing we can agree on is strict regulations would provide investors with better protection and, in general, bring a higher sense of clarity to the crypto world. The problem is the results would not come cheap. Custodians who have the resources to meet high regulatory standards would also have a higher price tag. Not all individuals or small businesses come with the financial capacity for a cream of the crop “SEC approved” custodian.
How the SEC can affect crypto custody services
It’s worth noting that the SEC’s approach to crypto regulation is an evolving process and there’s an ongoing debate on whether cryptocurrency should be classified as security. However, the Securities and Exchange Commission is known for their lack of clarity on such matters. So, there may still be changes in the future and we might end up with unexpected results.
But if the SEC continues to tighten restrictions on crypto custody, the standards for a qualified custodian may eventually become a luxury instead of a necessity. Moreover, this could increase the costs and complexity of crypto custody, potentially limiting the number of firms that offer such services.
On the other hand, you could argue that increased regulation may actually benefit the industry by promoting investor confidence and, overall, shining a new light on cryptocurrency.
Another key takeaway is the SEC’s move seems to have stemmed from concerns for crypto exchanges and platforms that may offer custody services. Perhaps it came from the collapse of FTX or past incidents with Kraken? What we do know is qualified crypto custodians who don’t have a trading or lending platform should already meet most of the proposed requirements.
Ultimately, the impact of the SEC on crypto custody will depend on the final implementation of new regulations and, more importantly, how the industry and leading firms adapt to those changes.