Why Does SEC Want to Stiffen the Rules for Crypto Custodians?

The Securities and Exchange Commission, under Gensler's direction,

Has put out additional recommendations that would "extend the scope" of the 2009 Custody Rules.

A five-member panel of the United States Securities and Exchange Commission (SEC) has voted 4-1 in favour of a proposal that could make it more difficult for cryptocurrency firms to serve as digital asset custodians in the future. The proposal, which is yet to be officially approved by the SEC, recommends amendments to the “2009 Custody Rule” that would apply to custodians of “all assets” including cryptocurrencies, according to a Feb. 15 statement from SEC Chairman Gary Gensler.

Gensler noted that some crypto trading platforms that offer custody services are not actual “qualified custodians.” According to the SEC, a qualified custodian is generally a federal or state-chartered bank or savings association, trust company, registered broker-dealer, registered futures commission merchant, or foreign financial institution.

Under the newly proposed rules, U.S. and offshore firms would need to ensure that all assets stored - including cryptocurrencies - are properly segregated, while these custodians would be required to meet additional requirements such as annual audits from public accountants, among other transparency measures.

Gensler said these amendments would “expand the scope” to all asset classes, but he also took a jab at the crypto industry: 

“Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. [...] Further, though some crypto trading and lending platforms may claim custody of investors’ crypto, that does not mean they are qualified custodians. Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto.”

SEC Chairman Gary Gensler recently warned investors of the risks associated with crypto platforms, noting that when these platforms go bankrupt, investors' assets often become the property of the failed company, leaving them with little recourse. Gensler pointed to the industry's track record to suggest that few crypto firms would be reliable enough to serve as qualified custodians.

Commissioner Hester Peirce believes that the SEC's proposal, while not "regulation by enforcement," is designed to have an immediate effect on the crypto industry. She believes that such stringent measures will force investors to remove their assets from entities that have developed sufficient safeguarding procedures to mitigate and prevent fraud and theft, leaving them more vulnerable to theft or fraud.

Also Read - Ripple May Win SEC Case With A Fine, Says XRP Lawyer.