Gensler opens new regulatory front for crypto firms: custody

Quick Take

  • Securities and Exchange Commission Chair Gary Gensler argued that crypto firms are not in compliance with current rules around safeguarding digital assets.
  • Gensler’s remarks, and a new proposed rule, indicate a new regulatory and legal headache for crypto firms in the U.S. and a push by regulators for firms to park customer assets with traditional financial institutions, like banks. 

SEC Chair Gary Gensler signaled an escalation to his post-FTX crackdown on the crypto industry on Wednesday, saying that digital asset firms are in broad violation of current custodial rules meant to safeguard customers.

“The current model in the crypto field is a model that takes control, one would say ownership, of those funds, and commingles that with thousands, and often hundreds of thousands or even millions of other customer funds,” Gensler told reporters following a 4-1 commission vote to further tighten custodial rules.

“Crypto exchanges today, generally how they’re modelled, do not meet the qualified custodian standards of the current rule” set by the SEC around custody of assets in 2009, he added.

It’s the latest area where the SEC chair plans to expand scrutiny of digital asset firms, raising the regulatory and legal risks for them even more following a high-profile settlement with Kraken that ended its U.S. staking-as-a-service business and a notice to Paxos that the SEC may sue the company over its involvement in the Binance USD (BUSD) stablecoin.

Unsecured creditors

The custodial moves come in reaction to hundreds of thousands of FTX, Celsius, BlockFi and Voyager customers becoming unsecured creditors in the bankruptcies of those firms last year. That status makes it unlikely customers will fully recover assets they parked with those companies, which legally must maximize payments to as many entities and people they owe money to as possible.

Because of Celsius’ terms of use, customer assets deposited with the firm technically belong to the company, not consumers, an issue that Gensler implied led to the decision to tighten custodial rules, and an explicit push toward exchanges keeping customer assets in banks and other traditional financial players rather than holding assets themselves. Gensler noted that current law defining custodians included the words “bank” and “broker dealer,” adding that “state-chartered trust companies, state-chartered banks, federally-chartered banks have in the past provided qualified custodial services.”

The markets regulator noted that other agencies on the state and federal level define what companies constitute a bank.

Industry complaints 

When asked about complaints from the industry that the SEC is effectively trying to ban cryptocurrency in the U.S., Gensler pushed back and called out Kraken in particular for not making an effort to register with the SEC.

“I couldn’t disagree more" he said. "Come into compliance. Provide the time-tested disclosures and protections to their investors.”

Gensler compared digital assets to the peer-to-peer and marketplace lending industry, which the SEC labelled as a securities-based industry in 2009. Those fintech companies came into compliance with securities laws, he noted in comparison to pushback from the digital asset industry.

“Some of the platforms publicly say 'we’ll never register',” Gensler said. “Some of them we end up bringing charges against.”

“This runway is increasingly getting short,” he added.

Disclaimer: The former CEO and majority shareholder of The Block has disclosed a series of loans from former FTX and Alameda founder Sam Bankman-Fried.

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