a16z Appeals: In the Age of Encrypted Staking, Ask the US SEC to Update Custody Rules

Last week marked an exciting time for technological innovation. The ethereum blockchain, the global, decentralized computer that anyone can use, is changing the way it verifies transactions in a long-awaited upgrade dubbed “merging.”

While providing more opportunities for innovation, the dramatic change highlights the legal uncertainty for crypto investors and asset managers. Strict adherence to the SEC’s “custodial rules” will keep asset managers acting on behalf of investors away from cryptocurrency staking. This contradicts the fiduciary duty that asset managers owe their clients for denying a legitimate and potentially lucrative source of income. This is Catch 22.

The law is clear: registered investment advisors must comply with the SEC’s custodial rules, which are designed to reduce the risk of investor misappropriation. More specifically, the rules typically require advisors to deposit client assets (funds and securities) with a “qualified custodian” (usually a bank or broker-dealer) and require independent public accountants to regularly verify assets.

Unfortunately, the regulatory uncertainty in the space can frustrate even the most compliance-conscious asset managers. There are only a handful of clearly qualified cryptocurrency custodians operating in the United States — and these few qualified custodians serve only a limited number of cryptoassets. Notably, when one of these qualified custodians provides crypto custody services, their services rarely extend to staking, voting, or other participation functions for crypto assets.

Investment advisors responsible for managing crypto assets have been staking assets on other blockchains for years, if possible.

While digital assets as a whole are often considered venture capital, there is an argument that not crypto-staking absolves customers of their obligations. Investment advisors have a responsibility to optimize portfolios and, where appropriate, to make informed governance decisions for their investments.

For example, managers who do not vote for shares they manage in General Electric (GE) or IBM (IBM), or refuse to pay dividends, risk legal action from customers and regulators. Crypto asset holders should receive similar protections from their investment advisors.

Asset managers, however, are in trouble. Custody rules continue to require advisors to hold cryptoassets in custody with custodians who may have insufficient arrangements for staking, voting or other participatory functions. Like all institutions, custodians have limited time and resources for onboard assets and related functions.

Holders of crypto assets are the biggest losers in all of this — deprived of robust crypto custody solutions, deprived of legal certainty to require their advisors to stake and/or vote on their assets, and deprived of reliability s return.

It doesn’t have to be this way.

This dilemma – which has been drawn more attention by the merger – is a solution uniquely positioned by the SEC. Unlike the many complex policy issues that encryption faces, this one can be easily resolved. The SEC could recognize novel features of certain cryptoassets, such as staking and voting, and adjust existing custody rules accordingly.

Updating SEC regulations is consistent with, and arguably necessary, two fundamental parts of the agency’s mission; protecting investors and maintaining order in the marketplace.

Given the scarcity of crypto custody solutions, the SEC can clarify that, in certain circumstances, registered investment advisors (non-qualified custodians) can self-custody cryptocurrencies using a combination of software and comprehensive internal controls. This does not necessarily lead to any loosening of regulatory rules – in fact, we strongly believe that the SEC should develop robust, technology-neutral principles for cryptocurrency regulation.  

For example, the SEC may adopt or modify the requirements:

  • Transparency of self-custodial crypto assets so that consulting clients can independently review their assets over the internet.
  • Investment advisors who self-custody cryptocurrencies, regularly assess the quality of the software they use and have some legal recourse against commercial and technical failures of any associated service provider.
  • Advisors provide strong and clear disclosures about the risks of cryptocurrency custody and the security measures it takes, and provide appropriate insurance for cyber risks and audit arrangements around cryptocurrencies.

We know these measures are possible because the best crypto asset managers have implemented one or more of them. Ideally, the SEC will support and regulate these measures through its inspection program, which already has the capability to assess and assess cryptoassets and risk programs.

In fact, the SEC has a long history of intense scrutiny of custody practices and often takes enforcement action to protect investors. These are good investor protections, and it seems reasonable to hold crypto asset managers to the same standards as other investment advisors.

If the SEC really wants to protect crypto-asset investors in the same way it protects investors in traditional investments, as its chairman recently announced, implementing the above recommendations will allow the committee to prove it in a meaningful way.

The SEC has the ability to address this issue on behalf of investors. We hope they choose to do so.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/a16z-appeals-in-the-age-of-encrypted-staking-ask-the-us-sec-to-update-custody-rules/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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