The US SEC recently announced a new proposed rule to govern cryptocurrencies and decentralized finance platforms in order to require securities compliance under certain conditions. Will your cryptocurrency or deFi platform be affected? Our guide breaks it down.
What are the Details of the new US SEC’s Proposed Rule for Cryptocurrencies and Cryptocurrency Custodians?
The U.S. Securities and Exchange Commission (SEC) proposed a new rule that would impose new regulatory requirements on cryptocurrency custodians. Here are some key details of the proposed rule:
- Registration: The proposed rule would require cryptocurrency custodians to register with the SEC as a means of providing regulatory oversight and ensuring compliance with regulatory requirements.
- Capital Requirements: Cryptocurrency custodians would be required to meet certain minimum capital requirements to ensure that they have the financial resources to meet their obligations to customers.
- Reporting: Cryptocurrency custodians would be required to provide regular account statements to customers, as well as notify customers of any material changes to their accounts.
- Recordkeeping: Cryptocurrency custodians would be required to maintain books and records that accurately reflect their transactions and holdings, as well as any other information required by the SEC.
- Security Controls: Cryptocurrency custodians would be required to implement appropriate security controls to safeguard customer assets, including multi-factor authentication, encryption, and other measures designed to prevent unauthorized access or theft.
- Compliance with other regulations: Cryptocurrency custodians would be required to comply with other regulatory requirements, such as those related to privacy and data protection, as well as any other regulations that may apply to their activities.
- Use of sub-custodians: Cryptocurrency custodians would be required to have policies and procedures in place to evaluate and monitor any sub-custodians that they use.
- Annual audits: Cryptocurrency custodians would be required to undergo an annual audit of their financial statements.
The proposed rule is designed to ensure that custodians of digital assets are providing appropriate levels of protection for customer assets and complying with applicable regulatory requirements. By meeting these requirements, custodians can help build trust with customers and demonstrate their commitment to upholding high standards of integrity and security in the management of digital assets. The rule is currently in the public comment period, and it is subject to change before it is finalized.
Who does the US SEC consider to be Cryptocurrency Custodian?
The U.S. Securities and Exchange Commission (SEC) has not provided a specific definition of what constitutes a “cryptocurrency custodian” for the purposes of its proposed rule. However, in general, a cryptocurrency custodian is an entity that holds and manages digital assets on behalf of others, similar to how a traditional custodian holds and manages physical assets such as stocks and bonds.
Cryptocurrency custodians may include a range of entities, such as:
- Digital Asset Exchanges: Many cryptocurrency exchanges offer custodial services for their users, holding digital assets in secure wallets on behalf of users.
- Digital Asset Trust Companies: Some companies have been formed specifically to offer digital asset custody services, operating as trust companies subject to state-level regulation.
- Traditional Banks: Some traditional banks have started offering custody services for digital assets, either directly or through partnerships with other companies.
- Broker-Dealers and Investment Advisers: Some broker-dealers and investment advisers also provide digital asset custody services for their clients.
Overall, the SEC’s proposed rule is intended to ensure that any entity that holds digital assets on behalf of others is subject to appropriate levels of regulatory oversight and compliance. The proposed rule is currently in the public comment period and is subject to change before it is finalized.
What Securities Compliance Obligations Currently Exist for Cryptocurrencies?
The regulatory framework for cryptocurrencies and digital assets in the United States is still evolving, and there is not yet a comprehensive set of securities compliance obligations that apply to all types of cryptocurrencies. However, there are a number of existing securities compliance obligations that may apply to certain types of cryptocurrencies, depending on how they are structured and marketed to investors. Here are a few examples:
- Securities Registration: If a cryptocurrency is deemed to be a security under U.S. securities laws, it may be required to be registered with the SEC, unless it qualifies for an exemption. In general, a security is an investment in which the investor expects to profit from the efforts of others, such as the efforts of a company or other third party.
- Anti-Fraud Obligations: Cryptocurrency issuers and promoters are subject to anti-fraud obligations under U.S. securities laws, which prohibit them from making material misstatements or omissions in connection with the offer or sale of securities. This includes false or misleading statements about the nature of the investment, the risks involved, and the potential returns.
- Broker-Dealer Registration: If a person or entity is engaged in the business of buying and selling cryptocurrencies for others, they may be required to register as a broker-dealer with the SEC and become a member of a self-regulatory organization such as FINRA.
- Investment Adviser Registration: If a person or entity is providing investment advice to others with respect to cryptocurrencies, they may be required to register as an investment adviser with the SEC.
- Anti-Money Laundering (AML) and Know-Your-Customer (KYC) Obligations: Cryptocurrency exchanges and other platforms that enable the trading of cryptocurrencies are subject to AML and KYC obligations under U.S. anti-money laundering laws.
Overall, the regulatory landscape for cryptocurrencies is complex and evolving, and the obligations that apply to a particular cryptocurrency will depend on its specific characteristics and how it is marketed to investors. It is important for issuers, promoters, and other market participants to consult with legal counsel to understand their compliance obligations and ensure that they are complying with applicable securities laws and regulations.
How will the New Proposed Rule Change Securities Compliance for Cryptocurrencies?
The SEC’s new proposed rule related to cryptocurrency custodians is focused specifically on the custody of digital assets, rather than on cryptocurrencies more broadly. However, this proposed rule could have significant implications for the securities compliance obligations of custodians of certain types of cryptocurrencies, particularly if they are deemed to be securities under U.S. securities laws.
Under the proposed rule, custodians of digital assets that are securities or are held in connection with securities transactions would be subject to a new set of regulatory requirements. These requirements would include:
- Registering with the SEC as a “special purpose broker-dealer” and becoming a member of a self-regulatory organization such as FINRA
- Complying with existing broker-dealer regulations, such as financial responsibility rules and recordkeeping requirements
- Implementing policies and procedures to safeguard digital assets from theft or loss, and to ensure compliance with securities laws and regulations
- Providing regular reports to the SEC regarding the custody of digital assets, including any material events or changes in custody arrangements
If this proposed rule is adopted, it could have significant implications for custodians of certain types of cryptocurrencies that are deemed to be securities under U.S. securities laws. These custodians would need to ensure that they are complying with the new regulatory requirements and implementing appropriate policies and procedures to safeguard digital assets from theft or loss.
It is important to note, however, that the impact of this proposed rule on the broader cryptocurrency industry may be limited, as it is focused specifically on custodians of digital assets that are securities or are held in connection with securities transactions. Cryptocurrencies that are not deemed to be securities may not be directly impacted by this proposed rule, although other securities compliance obligations may still apply to issuers, promoters, and other market participants.
What does it mean to Register as a Custodian with the US SEC?
Registering with the SEC as a custodian would likely involve a process similar to registering as a broker-dealer or other securities professional.
The registration process would likely require custodians to file various forms and disclosures with the SEC, including a Form BD application for registration as a broker-dealer. The SEC would review these filings and may request additional information or documentation to assess whether the custodian meets the legal and regulatory requirements for registration.
If the custodian is approved for registration, they would be subject to ongoing regulatory obligations, including recordkeeping requirements, reporting requirements, and compliance with applicable securities laws and regulations. They may also be subject to periodic examinations by the SEC to ensure ongoing compliance.
It is important to note that the specific details of the registration process and regulatory requirements would depend on the final version of the SEC’s proposed rule related to cryptocurrency custodians, which has not yet been adopted. Market participants should closely monitor any new regulatory developments and work with legal counsel to ensure that they are complying with all applicable securities laws and regulations.
How to Tell if your Cryptocurrency or DeFi Project is considered a Custodian?
A cryptocurrency or DeFi project could be considered a custodian if it is involved in holding or storing digital assets on behalf of others, particularly if those digital assets are deemed to be securities under U.S. securities laws.
For example, a cryptocurrency exchange that holds customer funds in a hot or cold wallet, or a DeFi protocol that allows users to pool their assets in a smart contract, may be considered a custodian under certain circumstances. However, whether a particular project would be deemed to be a custodian would depend on a variety of factors, including the specific features and functions of the project, as well as the regulatory regime in which it operates.
Given the rapidly evolving regulatory landscape in the cryptocurrency and DeFi space, it is important for market participants to closely monitor regulatory developments and work with legal counsel to ensure compliance with applicable securities laws and regulations. This may involve performing a careful analysis of the project’s features and functions to assess whether it could be considered a custodian, and taking steps to implement appropriate policies and procedures to mitigate regulatory risks.
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