Regulators Can’t Approve Crypto Custody Services Yet, But It’s Not For Lack of Trying

The Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC) have come out to address some of the stringent issues they’re facing with providing regulatory compliance for cryptocurrency custodians.

On Monday, both agencies released a joint statement where they outlined the various factors which they consider when contemplating the approval of a broker-dealer application by a company as pertaining digital assets, including the procedures that should be followed in order to ensure compliance with the regulator’s Customer Protection rules.  

Essentially, broker-dealers are registered organizations which have the power to purchase and trade assets, both on their behalf and those of their customers. Given the prominence of cryptocurrencies and the increase in institutional interest, multiple companies have attempted to get approval to become crypto custodians and make crypto-based transactions on behalf of institutional investors. In particular, the statement details that customer funds are to be kept discernibly differently from those of the firm, thus increasing the ability of the firm to reimburse customers in the event of the broker-dealer’s failure. 

However, the report outlines that it hasn’t come up with a means through which cryptocurrency custody services can show that the assets they hold are controlled by them as well. Both agencies claimed that merely holding a Bitcoin wallets key, for instance, isn’t sufficient, as a separate party could have a copy of the key and perform unauthorized transactions.  

In addition, if such an occurrence were to manifest, then the custodian won’t be able to reverse it, and the assets would most likely be lost. 

In addition to the problems facing custodial services, the statement also shed some light on the problems of registering some non-custodial services, including broker-dealer transactions and over-the-counter platforms. Bookkeeping policies, as well as liquidation with respect to the Securities Investor Protection Act of 1970, were also discussed. 

The unfortunate inability of both agencies to definitively approve cryptocurrency asset custodians is coming at a time when institutional interest in crypto assets is surging. Multiple cryptocurrency investment and asset management firms have alluded to this, such as crypto lender Genesis Capital, which reportedly saw as much as a three-fold increase in institutional trading volumes over the past year. 

However, just as it is with cryptocurrencies in general, the lack of regulatory approval hasn’t stopped multiple crypto-based companies from entering into the sub-industry and blossoming. Earlier this year, cryptocurrency exchanges Coinbase announced that its Coinbase Custody service had crossed the $1.3 billion thresholds in asset holdings. 

1/ Last week Coinbase Custody CEO @sammcingvale and Coinbase CISO @SecurityGuyPhil visited the UK to discuss the institutional cryptoeconomy with a range of prospects and clients. pic.twitter.com/gA5nu9NWUR

— Coinbase Institutional 🛡️ (@CoinbaseInsto) June 13, 2019

Regardless, the fact that both agencies are working on the approval of custody services is something that would strike much relief in the hearts of custody services and institutions. 

For the former, it’s evidence that they can continue to give their asset holdings to custody services without the fear of any regulatory crackdown. For the latter, it’s an incentive that cryptocurrencies themselves aren’t a long way from being fully regulated as well. As long as the investor protection issue can be solved, approval is a given.