FTX exchange collapse in November 2022 and US Securities and Exchange Commission (SEC) vote The move to expand the types of digital assets included in the so-called custody rule in February 2023 shows that regulators are moving quickly to take action they think will protect the crypto industry.
As much as regulators have been chastised by crypto insiders for not understanding the space and setting precedents that stifle innovation, requiring exchanges to have separate custody from trading would be enormously positive for the future of crypto.
Mike Belshe is the CEO and co-founder of BitGo.
Do crypto regulatory solutions outperform traditional finance?
Modern traditional finance separates business lines such as trading, financing and custody and uses a robust system of checks and balances. It therefore makes sense for digital assets to follow the same framework, learning from the past mistakes of traditional finance. Even considering a small subsection of the history of traditional finance regulation, the progress from the FTX crash to sensible rulemaking regarding crypto custody was rapid.
For example, in the years before the stock market crash of October 1929 (“Great Crash”), people bought a large number of stocks and speculated by borrowing money to buy more shares. This worked as long as stock prices kept rising, the decade of the Roaring Twenties was one of a 10-year bull market with a lot of pump and dump, insider trading and market manipulation.
When the crash happened, people who bought their shares of stock on margin lost the value of their stock portfolios and owed money wherever they went to borrow money to buy their stock. When people tried to get their money out of financial institutions, panics broke out and even the New York Bank of the United States collapsed.
See also: US Lawmakers Argue SEC Accounting Policy Undermines Secure Crypto Custody
As a result of the lessons learned from the Great Crash, the SEC was created and consumer protections were established. The SEC’s recent actions also reflect a response to lessons learned, and this proposed rule change aims to bring order and protect market participants.
Forward-moving crypto regulation solution
The SEC is proposing that requiring registered investment advisors to use an independent, regulated, qualified custodian is prudent and in the best interest of the digital asset industry. Qualified custodians who have a fiduciary duty to customers will keep customer funds in segregated accounts. The custodian must also meet rigorous regulatory standards, including audits, to safeguard those funds.
Speaking as the co-founder and CEO of one of the most important custodians in the cryptocurrency industry, I propose additional barriers to protect investors:
- Regulators should also require issuers of stable coins to hold 1:1 reserves in Federal Deposit Insurance Corporation (FDIC)-insured banks. Although stablecoins are considered redeemable with the assets that back them, no legal requirement exists for issuers to maintain proper reserves and prevent congestion as occurred with the then-unregulated New York Bank. Requiring quarterly and real-time reporting of stablecoin reserves on mint-and-burn activities would be a sensible step.
- Make all exchanges on-chain auditable. it will remedy proof-of-reserve statement From a partial solution that provides some transparency to a more complete one. FTX mixed its digital asset holdings with fiat and allowed liabilities to far exceed those holdings with highly undesirable consequences. Going forward with this idea, the government could also create a digital registry of loans on the blockchain.
See also: Coinbase, Anchorage Digital Say They’ll Be Fine Under SEC Proposal
While no one would have ever wished for the collapse of FTX, a similar crash prompted the necessary rule-making and role-playing in traditional finance to protect investors. Despite the growing pains, the crypto industry is developing very quickly by learning from the mistakes of its own industry and traditional finance first – a trajectory that is likely to continue.
The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.