Coinbase Says SEC’s Proposed Custody Rule Change Unnecessarily Distinguishes Crypto DL News

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The Securities and Exchange Commission wants to toughen rules on where investment firms can store their clients’ assets. Coinbase pushes back.

Chief Legal Officer Paul Grewal said the exchange is in line with the spirit of the SEC’s proposed overhaul as part of a set of laws that were last updated more than a decade ago. following Bernie Madoff’s Ponzi scheme.

But Grewal said many details of the proposal were wrong.

This proposal unnecessarily singles out crypto and makes inappropriate assumptions about securities markets-based custodial practices, he wrote on Twitter.

That said, like other recent SEC actions, this proposal unnecessarily targets crypto and makes inappropriate assumptions about securities markets-based custody practices. Our comments explain our views in detail with a few highlights below. 3/7

— paulgrewal.eth (@iampaulgrewal) May 9, 2023

At stake is the fate of the crypto custody. SEC rules currently require investment advisers to hold client assets with qualified custodians such as banks and savings trusts that meet certain SEC requirements.

After the FTX scandal, the SEC wants to modernize them again, this time in part by bringing crypto into the fold of assets that must be held by such qualified custodians, or QCs.

Grewal said the SEC should continue to allow state-licensed banks to hold crypto assets on behalf of investors.

Coinbase recently spoke out against the regulator, serving the agency with a lawsuit after the SEC gave the exchange a notice of intent to file a lawsuit. Meanwhile, a banking crisis has rocked U.S. markets as investors question the reliability of financial institutions.

NOW READ: Banking Regulators Won’t Ban Crypto, They’ll Starve It

The Qualified Custodian, or QC, rules were tightened in the early 2010s amid the fallout from the Madoff scandal, which robbed investors of billions. The recent overhaul is a response to the many scandals that have hit crypto lately, particularly the collapse of the Sam Bankman-Frieds FTX exchange.

Many crypto exchanges lend and borrow from clients while offering custodial services. In the case of FTX, investors thought their money was being carefully kept in separate accounts, only to find after the exchange collapsed that their funds were mixed with FTX.

With the swap in bankruptcy court, investors now have to line up and wait for their money to be returned.

Among other issues in the QC proposal, the SEC asked whether it should limit the types of firms allowed to serve as QCs to only federally licensed banks.

Coinbase operates a state-licensed QC, Coinbase Custody. That would remain a QC under the new proposal, Grewal noted. But he said it was dangerous to limit the types of companies that could be considered custodians.

State banks are no less stable than federal banks, he said, and in many cases federal regulators react more quickly to crises.

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State financial regulators are often more nimble than their federal counterparts in responding to technological and economic change, Grewal said.

For example, he said, Coinbase Custody is strictly regulated by the New York Department of Financial Services under its crypto-specific framework.

Grewal warned that restricting QC’s definition to only federal entities would force investors to find homes for billions of dollars in assets and reduce competition in the space, weakening existing custody services.

Coinbase Custody and its competitors are developing advanced technology to protect and segregate these assets, Grewal wrote. Without it, investor clients would be on their own, exposing them unnecessarily to cyber threats, fraud, and other risks that institutional custodians address.

He estimated that if the SEC goes ahead and excludes state-licensed banks from holding investors’ assets, the number of QCs could drop by as much as 77%.

Custody in crisis

Custody of crypto assets has become a hot issue amid what many crypto proponents see as the industry’s systematic unbanking, amid an ongoing banking crisis.

Some believe the federal government is engaged in a deliberate campaign to block crypto from its access to fiat dollars, something called Operation Chokepoint 2.0.

NOW READ: Lawyer who challenged Operation Choke Point rallies crypto to fight illegal regulatory crackdown

The failure of three crypto-enabled banks this year included Silicon Valley Bank, which offered crypto custody to customers.

And in January, the Fed turned down a request from crypto-specialized Custodia Bank to join the Federal Reserve system. The Wyoming-based bank is currently suing the regulator over the process.

In parallel, the SEC has cracked down on crypto firms, including the custody.

SEC Chairman Gary Gensler made it clear that FTX and similar scandals were on his mind when the SEC released the QC proposal in February.

Don’t get me wrong, he said then. Based on the general operation of crypto platforms, investment advisers cannot rely on them as qualified custodians.

The proposal followed SEC staff guidance issued in May 2022, known as Staff Accounting Bulletin 121.

Critics of SAB 121, including Republican lawmakers, have said it effectively financially punishes custodians of crypto assets, making providing such services unattractive.

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