Business

Erik Gibbs

SEC and FINRA weigh in on crypto custody

Two of the primary regulators overseeing financial activity in the United States have weighed in on the subject of cryptocurrency custody. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) jointly published a lengthy piece on regulatory compliance issues for the activity in hopes of helping investors better understand why the system moves the way it does. Put simply, the regulators don’t believe crypto custody is possible.

The statement indicates that the two groups cannot determine any conceivable circumstance where crypto custodians would be able to comply with the SEC’s Customer Protection Rule. That rule “requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm’s assets, thus increasing the likelihood that customers’ securities and cash can be returned to them in the event of the broker-dealer’s failure,” according to the statement.

The publication also asserts that a custodian most likely would not be able to comply with another requirement, that of demonstrating that it controls the assets it holds. A private key, they say, isn’t enough to demonstrate ownership, as another individual or entity could have access to that key, as well, and could conduct transactions.

The regulators explain, “Generally, a broker-dealer that fails and is unable to return the customer property that it holds would be liquidated in accordance with SIPA [the Securities Investor Protection Act]. Under SIPA, securities customers have a first priority claim to cash and securities held by the firm for securities customers. Customers also are eligible for up to $500,000 in protection (of which up to $250,000 can be used for cash claims) if the broker-dealer is missing customer assets. These SIPA protections apply to a ‘security’ as defined in SIPA and cash deposited with the broker-dealer for the purpose of purchasing securities. They do not apply to other types of assets, including, importantly, assets that are securities under the federal securities laws but are excluded from the definition of ‘security’ under SIPA.”

For now, it appears as though custodians wanting to get into the crypto industry are going to have to go back to the drawing board or at least prove that they can respond to the assertions outlined by the SEC and FINRA.

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