On Wednesday, the Securities and Exchange Commission voted to expand asset custody rules for cryptocurrency investment advisors and require financial institutions that oversee cryptocurrencies to obtain federal and state registration.
The proposed rule, passed by SEC 4-1, would require investment advisors to hold cryptocurrency custodial accounts in the same way they hold other clients' assets, such as stocks, bonds, or mutual funds.
Investment advisors direct banks, broker-dealers, and other financial institutions to "hold" clients' securities and related assets in custodial accounts. These establishments charge a fee for their services and must abide by the rules.
The SEC proposal comes amid a wave of cryptocurrency bankruptcies, including FTX, that have put regulatory pressure on the nascent sector, which has faced limited government and state oversight. Even when there is no separation between investors' funds and the assets of the custodial platform, custodial issues arise in the event of bankruptcy. During Celsius Network's bankruptcy proceedings, a federal bankruptcy judge ruled that customer deposits in the network belonged to Celsius, not the customers.
SEC Chairman Gary Gensler said the changes will help investment advisors ensure that their crypto assets are not "misused, lost or misused".
“Investors who work with advisors will get the proven protection they deserve for all of their assets, including crypto assets,” Gensler said.
However, Hester Pierce, the only SEC commissioner who voted against the proposal, said she was concerned that it might be difficult for smaller investment advisors to comply with the changes and that it would reduce the number of eligible cryptocurrencies.
While some regulators encourage banks to hold assets for crypto accounts, cryptocurrency exchanges often act as custodians for their investors.
Pearce said many crypto assets with investment advisors are already held in larger funds or accounts subject to existing custodial rules. He added that the SEC's statements equating cryptocurrencies with securities are misleading.
“These ads are prompting investment advisors to immediately stop advising their clients about cryptocurrency,” said Pearce. “Overall, the statement that ‘nearly every cryptocurrency is a security’ appears to be part of a broader strategy to seek full jurisdiction over cryptocurrencies.”
Max Schatzow, co-founder and partner at RIA Lawyers LLC, which represents investment advisors, downplayed Peirce's concerns about the trustees. According to him, most cryptocurrency exchanges have similar registrations with federal and state banks.
"So there is a way (for cryptocurrency exchanges) to meet the definition of a qualified custodian under the (proposed) rules," Shatsov said.
Coinbase (COIN), which has been critical of the SEC's recent regulatory actions, today backed the regulator's action, even as a number of crypto companies announced they were considering new SEC rules.
“We fully agree that investors deserve reassurance that their assets are safe. We remind you that our clients' assets are segregated and protected. We support the Commission's efforts to provide all investors with the same protections that already exist for CCTC clients.” It was revealed in a statement from Coinbase General Counsel, Paul Grewal.
However, cryptocurrency investors should understand that if they do not use the expert advisor, the Wednesday trades will not apply to their assets, Shatov said.
“Today’s proposed rule would only affect cryptocurrency investors to the extent that they operate through a Registered Investment Advisor (RIA),” he said. "If they are not working with a registered investment advisor, they will not be eligible for this offer."