‘Segregate customer assets,’ New York financial regulator warns

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The New York State Department of Financial Services (NYDFS) has warned exchanges operating in the state against commingling customer assets with their own funds and may be subject to ad-hoc site visitation to confirm their compliance.

The warning comes in the form of new guidance issued by the NYDFS. The NYDFS oversees New York’s robust BitLicense regime: any digital asset company that either resides in or offers services to people who live in New York must apply for a BitLicense and comply with the rigorous requirements of the licensing process.

“As stewards of others’ assets, virtual currency entities (“VCEs”) that act as custodians (“VCE Custodians”) play an important role in the financial system and, therefore, a comprehensive and safe regulatory framework is vital to protecting customers and preserving trust,” the Guidance’s introduction read.

Under the guidance, custodians are required to “separately account for and segregate customer virtual currency from the corporate assets of the VCE Custodian and its affiliated entities, both on chain and on the VCE Custodian’s internal ledger accounts.” Custodians should be able to demonstrate compliance with this requirement upon request from the NYDFS. Such requests may take the form of ongoing monitoring, routine onsite examination, ad-hoc visitation, or otherwise, according to the guidance.

Where customers have transferred digital assets to the custodian for safekeeping, the NYDFS expects that the custodian will take possession only to carry out such custody and/or safekeeping. The guidance explicitly excludes the possibility of custodians establishing a creditor-debtor relationship with the customer.

Further, any custodial outsourcing done to a third party must comply with the NYDFS’ guidance. Such arrangements are also considered to be a ‘material change to the business’ of a licensed entity and is thus to re-approval by the NYDFS.

The guidance also requires custodians to disclose in writing the terms and conditions associated with its products, services, and activities; obtain acknowledgment of receipt of such disclosure prior to transacting with the customer; and make clear that the agreement is one of a custodial nature rather than a debtor-creditor relationship, including the disclosure of how customer assets are segregated and the parameters within which a custodian may use the assets.

It’s not hard to see what is animating the NYDFS in issuing this latest guidance. A spate of high-profile bankruptcies has rippled throughout the digital asset industry, and many customers are now finding that the assets they have entrusted to digital asset platforms stopped belonging to them the second they were turned over. The bankruptcy judge overseeing Celsius‘ unwinding recently ruled that the $4.2 billion worth of client assets deposited into the platform’s Earn program legally belonged to Celsius and could be used to fund the bankruptcy proceedings; customers would have to get in line with all of Celsius’ other creditors.

Despite grumbling from some corners of the industry, New York’s BitLicense regime is among the most robust in the world. It must be doing something right because FTX, the firm which poured gasoline on the industry’s ongoing financial fire if not struck the match itself, was still waiting on BitLicense approval from the NYDFS when it went bust.

In November, Adrienne Harris, the superintendent of the NYDFS, advocated for the New York licensing regime to be adopted nationally.

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