SEC crypto custody regulations are likely to change soon, following the proposal by the US Securities and Exchange Commission for a new model on how investment advisers and fund managers custody digital currencies. According to SEC chairman Paul Atkins, federal securities regulations have failed to catch up with the developments in Bitcoin since 2008.
This proposal will revise the custody provisions in the Investment Advisers Act of 1940 and the Investment Company Act of 1940. According to the SEC, the revisions will make it easier for advisers and investment companies to understand the rules concerning cryptocurrency.
Bitcoin has evolved from an experiment to a multi-trillion-dollar market for asset investment. However, much of the regulatory structure regarding the custody of investments was developed even before the existence of digital currencies.
The current SEC proposal tries to close the loophole by formulating a regulation model specifically suited for crypto-assets’ custody, transfer, and security.
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What Is the SEC Crypto Custody Proposal?
The SEC crypto custody proposal will define the standards of operation for registered investment advisers, registered investment companies, and business development companies that own cryptocurrencies.
Among the important updates will be the ability for certain cryptocurrencies to be stored using a self-custodial mechanism as long as certain standards are met. Under the SEC crypto custody proposal, state-chartered trust companies can be recognized as crypto custodians for crypto assets managed by an adviser or regulated fund.
This might enable more institutions to offer custody services than are currently available for the holding of traditional assets within the traditional banking and brokerage systems.
Self-custody also needs to be secured by the SEC. This includes methods for ensuring that private keys are secure and that transactions are recorded independently and verified.
The plan is designed to help manage risk associated with digital assets, which could include loss, theft, transfers, and misuse.
Why SEC Crypto Custody Rules Matter
Crypto custody continues to remain an issue of relevance for investment advisers and fund managers since cryptos work in ways that differ from the stock, bond, and other conventional investments.
Unlike traditional investments, Bitcoin and other cryptos can be transferred directly from one wallet to another within the blockchain network without the need for settlement and custody mechanisms in place. Private keys continue to be relevant in determining ownership of the assets.
However, the SEC crypto custody rule tries to take into account the differences between crypto assets and older assets, rather than apply custody rules that would remain the same.
In the case of investment advisers, the definition of custody rules might help to understand what digital assets should be held without breaking the law. The same might be true for regulated funds and crypto assets investment approaches.
According to Atkins, the proposal would give a compliance route for advisers and funds that had been unsure how crypto assets would be held under the existing custodial standards.
SEC Expands Its Broader Crypto Regulatory Work
The SEC crypto custody regulation is among the regulatory measures being undertaken by the SEC as part of the efforts being spearheaded by Atkins.
In his October 1 statement, Atkins referred to some of the other initiatives that the SEC is undertaking, such as tokenized securities, crypto asset categorization, broker-dealer interfaces, and the August regulation titled Regulation Crypto Assets.
Among other regulatory measures that the SEC has been taking is the regulation of tokenized securities. According to Atkins, other regulations will follow.
The custody proposal, thus, deals with one specific aspect of the larger crypto market: how investment advisers and funds under regulation can hold digital assets safely while satisfying federal regulations.
What Happens Next for SEC Crypto Custody?
The Securities and Exchange Commission has begun the process of seeking public comments in relation to the proposal. The commenting period shall be open for sixty days following the publication of the proposal in the Federal Register.
Investment advisers, funds, crypto firms, custodians and other interested parties can provide their comments on the proposed rules. Issues that may get discussed include those relating to self-custody, state-chartered trust companies and protection of clients’ assets.
However, the proposal is not an official ruling, and its terms may be subject to further revision following the review of public comments by the SEC.
Nevertheless, the SEC crypto custody proposal provides market participants with an understanding of the regulator’s approach toward the issue of custody of digital assets. In case of adoption, the regulations will create a more structured environment for custodianship of Bitcoin and other cryptocurrencies.
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