The SEC Proposes New Crypto Custody Rules, Here Are the Key Points

United States Securities and Exchange Commission or SEC proposes new rules regarding the custody of crypto assets by registered investment advisors and regulated funds.

The proposal includes the possibility of self-custody under certain conditions, the use of state-level trust companies, and updates to digital asset custody provisions.

The SEC's proposal on crypto custody is significant because the old rules were designed when investment assets were still dominated by stocks, bonds, and traditional instruments.

Meanwhile, investor demand for crypto asset exposure continues to grow, but not all custodians are capable of storing new crypto assets or have the appropriate security infrastructure.

Key Takeaways

• The SEC opened a limited self-custody pathway for investment advisers and regulated funds.

• State trust companies can act as custodians of crypto assets under certain conditions.

• This proposal is not yet a final rule and is still going through a 60-day public consultation period.

Why Does the SEC Crypto Custody Rule Need to be Updated?

Current crypto custody rules require client assets to be held by a custodian that meets certain requirements.

The problem is, traditional custodians don't necessarily provide services for emerging crypto assets or those with specific technical characteristics.

This situation creates uncertainty for crypto investment advisers when offering digital asset-based investment strategies.

Source: X/@SECGov

The SEC stated that the proposal is designed to create a clearer path to compliance while maintaining protections against the risks of loss, theft, misuse, and embezzlement of assets.

Read Also:SEC Updates Rules, Blockchain-Based Digital Stocks Coming Soon?

Three Key Points of the SEC Crypto Custody Proposal

1. Self-custody is permitted under limited conditions.

The term self-custody in this proposal does not mean that retail investors are free to hold their own assets without intermediaries.

The concept primarily refers to investment advisors holding clients' crypto assets or managed funds when a qualified custodian is unavailable.

Advisors must demonstrate that custodians are unavailable before taking over custody and re-evaluate the situation quarterly.

They are also required to have asset security expertise, a private key management system, a transaction approval mechanism by at least two people, and a blockchain address that separates each client's assets.

Additionally, cybersecurity systems should be reviewed at least once a year.

Within the first six months after taking custody, the advisor also needs to obtain an internal control report from an independent public accountant and send account statements to the client at least quarterly.

Read Also: SEC Clears Way for US Stock Tokenization, Bittime Monitors Market Developments

2. State trust company can be a custodian

The second point in the SEC's crypto custody rules is the recognition of state trust companies as a custodian option.

Trust companies formed under state law can hold clients' crypto assets or regulated funds, as long as they meet established requirements.

Before engaging and annually thereafter, the investment adviser or fund must conduct due diligence.

They must ensure the company has a license from the state banking authority, asset protection procedures, audited annual financial statements, and internal control reports.

Client assets must also be separated from the trust company's own assets.

Read Also: How Does Blockchain Change the Stock Ownership System?

3. Custody and recording provisions are modernized

The SEC crypto custody proposal doesn't just address digital asset storage.

The SEC also proposed updating rules for broker-dealer custodians, certain exceptions to discretionary trading authority, and changes to audit and recordkeeping requirements.

Records stored and maintained through a blockchain network can also be used to fulfill record-keeping obligations under certain conditions.

The SEC also proposed changes to Form ADV and Form N-CEN to more clearly report information regarding crypto custody and fund tokenization.

Also Read: What Is Custody in Crypto? A Complete Explanation

Comparison of the Old Rules and the SEC Proposal

What is the Impact on Investors?

For institutional investors, this proposal could reduce barriers for investment advisors and funds looking to offer exposure to crypto assets.

Regulated funds also potentially have more strategic options because they don't always rely on traditional custodians.

However, this proposal is not a guarantee that all crypto assets are automatically safe or can be held by every investment adviser.

Self-custody still carries operational risks, cybersecurity risks, conflicts of interest risks, and mismanagement of private keys.

Therefore, the SEC includes the obligation of supervision, audit, segregation of assets, and periodic reporting.

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When Does the SEC Crypto Custody Rule Take Effect?

Currently, these provisions are still proposals, not final rules. The SEC will open a 60-day public comment period after the proposed release is published in the Federal Register.

Input from industry players and the public can still influence the content of the rules before the finalization process.

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FAQ

What is crypto custody?

Crypto custody is a service that provides the storage and security of crypto assets, including private key management, for investors, clients, or funds. Custody is distinct from the buying and selling of crypto assets.

Does the SEC proposal directly allow investors to self-custody?

Not directly. This proposal focuses on registered investment advisors and regulated funds, while self-custody by private investors is a different context.

How should investment advisers store crypto according to the SEC proposal?

Investment advisors can hold crypto if a qualified custodian is unavailable and all security requirements are met. These requirements include private key management, authorization by at least two individuals, segregation of asset addresses, security assessments, and reporting to clients.

What is the role of state trust companies in crypto custody regulations?

State trust companies can act as custodians of crypto assets for clients or regulated funds if they have adequate permits, security procedures, audited financial reports, and internal control systems.

When will the SEC's crypto custody rules go into effect?

There's no effective date yet, as the rule is still a proposal. The SEC will accept public comment for 60 days before making a final decision.