New York Pressures Crypto Custodians To Keep Client Assets Discrete

New York is extending its hard line on cryptocurrency, with the state warning digital-assets custodians to keep customers’ funds separate from their own and disclose how they are doing so.

The guidance, announced on January 23 and described by the state’s Department of Financial Services (NYDFS) as the first such rule in the U.S., follows a moratorium on new crypto miners introduced last November 2022 and the introduction of the state’s BitLicense in June 2015, which allows a company to conduct digital-currency business activity in New York but requires a difficult and costly application.

These guidelines apply to BitLicense holders and also to limited-purpose trust companies that provide crypto custody services.

“Commingling client funds is a big no-no in traditional finance and there is no reason for crypto to be any different,” says Omid Malekan, an adjunct professor at the Columbia University business school. “Segregated accounts make it easier to audit a custodian during normal operations and to unwind one in the event of bankruptcy.”

Although presented as guidelines, the new rules are meant to ensure companies “emphasize sound custody and disclosure practices to better protect customers in the event of an insolvency or similar proceeding.”

There have been several high-profile failures of cryptocurrency-based companies, most notably the November collapse of Bahamas-based FTX.

“It’s timely, but truth be told, it was something we had on our policy roadmap even before FTX,” said Adrienne Harris, the superintendent of NYDFS.

That is not far-fetched given the state’s prior moves.

“Segregation of assets and reducing the risk of credit exposure in appearance and in fact at the custodial level is the first logical step in rehabilitating our industry from the negative news cycles and allows for the development of constructive, inclusive, and secure digital asset financial services,” says Jack McDonald, CEO of Standard Custody & Trust, one of the companies affected by the guidelines.

Standard is one of about 30 companies granted charters under the New York Banking law to operate as limited liability trust companies authorized to provide digital asset custody, according to the NYDFS website. Holders of BitLicenses include automated teller machine provider Coinsource and the Ripple transfer service that employs the XRP cryptocurrency.

New York’s tough stance on digital assets has led to an exodus of bitcoin miners, but given its central role in global finance, regulators have doubled down on oversight of the digital asset industry.

“While I would never be foolhardy enough to say that no New Yorker will be harmed in all of this, I think it’s very fair to say that New Yorkers are better off than anybody else in the country because of the framework we have,” said Harris.

With $1.3 trillion wiped from cryptocurrency’s value last year, with at least some of the blame falling on lack of effective government supervision, New York’s regulators may have a point.

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