The regulator claimed the guidance is intended to offer “greater clarity regarding standards and practices.”
The New York State Department of Financial Services (NYDFS) urged firms to set apart customers’ cryptocurrency holdings from their own assets.
The watchdog argued that co-mingling funds could trigger a significant financial loss for investors.
The NYDFS’ Recommendation
New York’s financial watchdog issued guidance to state-regulated companies on how they should better protect clients in the event of potential insolvency. It outlined the increasing interest in cryptocurrencies over the past few years and insisted that entities should maintain enhanced control of their customers’ holdings. The agency also believes the market needs to function under an appropriate regulatory framework:
“As stewards of others’ assets, virtual currency entities (VCE) that act as custodians play an important role in the financial system and, therefore, a comprehensive and safe regulatory framework is vital to protecting customers and preserving trust.”
The NYDFS urged organizations to keep consumers’ crypto possessions separate from other assets. “It is expected that a VCE Custodian will not co-mingle customer virtual currency with any of the VCE Custodian’s own virtual currency or with any other non-customer virtual currency,” the department added.
They should also release records and maintain a “clear internal audit trail” to identify people about any transactions involving their ownings.
The regulator said custodians should not use users’ crypto assets to settle separate financial services, such as guaranteeing an obligation or extending credit.
Subsequently, they must “clearly disclose” to clients the general terms and conditions under which they keep their stash.
“Further, the department expects a VCE Custodian to make its standard disclosures and customer agreement readily accessible to customers on its website, in a manner consistent with New York laws and regulations,” the guidance concluded.
Such Measures Should Have Existed Before FTX’s Meltdown
Adrienne Harris – the superintendent of NYDFS – opined that the aforementioned guidance could positively impact the cryptocurrency industry and prevent future collapses. However, she believes the regulator should have acted before the demise of FTX.
The exchange filed for bankruptcy in November last year after failing to honor customer withdrawal requests. One of the accusations against its former CEO – Sam Bankman-Fried (SBF) – is that his firm co-mingled users’ funds with Alameda Research, which eventually harmed numerous investors.
The 30-year-old American has pleaded not guilty to the charges against him. A trial set for October 2, 2023, will determine whether he played a role in the fallout.