The SEC is proposing tougher rules as part of its crackdown on crypto custody

A five-member panel of the United States Securities Exchange Commission (SEC) has voted 4-1 in favor of a proposal that could make it more difficult for cryptocurrency firms to serve as digital assets in the future.

The proposal, which has not yet been officially approved by the SEC, recommends that changes to the “2009 Custody Rule” would apply to custodians of “all assets” including cryptocurrencies, according to a Feb. 15 statement from SEC Chairman Gary Gensler.

Gensler stated that currently some crypto trading platforms that offer custodian services are not actual “qualified custodians.”

According to the SEC, a qualified custodian is usually a federally or state-chartered bank or savings association, trust company, a registered broker-dealer, a registered futures commission dealer, or a foreign financial institution.

In addition, to become a “qualified custodian” under the newly proposed rules, US and offshore firms will have to ensure that all custodial assets – including cryptocurrencies – are properly segregated, while these custodians will be required to jump through several hoops such as annual audits by public accountants, including transparency measures.

While Gensler said these changes would “broaden the scope” to all asset classes, he specifically took a shot at the crypto industry:

“Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. […] Furthermore, even though some crypto trading and lending platforms may claim to deposit investors’ crypto, that does not mean they are qualified custodians. Instead of separating investors’ crypto, these platforms have mixed these assets with their own crypto or other investors’ crypto.”

“When these platforms go bankrupt — which we’ve seen time and time again recently — investors’ assets often become the property of the failed company, leaving investors in line at the bankruptcy court,” the SEC chairman added.

Gensler also pointed to the industry’s track record to suggest that few crypto firms would be trustworthy enough to serve as qualified custodians:

“Make no mistake: Based on how crypto platforms generally operate, investment advisors cannot rely on them as qualified custodians.”

However, not all SEC members are on board with Gensler’s plans.

While the proposal is not “regulation by enforcement” per se, Commissioner Hester Peirce said that “the latest SEC statement appears to have immediate effect” to bring down the crypto industry:

“Such sweeping statements in a proposed rule appear to have immediate effect, a feature that suggests releases should not play. These statements encourage investment advisors to withdraw immediately from advising their clients with respect to crypto.”

As for the proposal itself, Peirce believes it will do more harm than good.

She said such strict measures would force investors to remove their assets from entities that have developed adequate security procedures to reduce and prevent fraud and theft:

“The proposal would expand the reach of custody requirements for cryptoassets, while likely shrinking the ranks of qualified cryptocustodians. By insisting on an asset-neutral approach to custody, we could be making investors in cryptoassets more vulnerable to theft or fraud, not less.”

As for next steps, Peirce noted that the agency will soon schedule a 60-day comment period once the proposal has been published in the Federal Register.

Related: US lawmakers and experts debate SEC’s role in crypto regulation

However, the Commissioner is concerned that this timeframe is not sufficient to allow the public to analyze all aspects of the proposal.

Those who voted in favor of the proposal hope to implement the new rules within 12 to 18 months, according to Peirce, who added that it was an “aggressive timeline” given the changes being proposed.