SEC Could Halt Hedge Funds from Working with Crypto Custodians

The SEC will vote on a proposal on Wednesday that could prevent hedge funds, pension funds, and private equity firms from working with crypto custodians.

Another day, another SEC action against crypto. Bloomberg has reported that the United States Securities and Exchange Commission (SEC) will vote on a proposal on Wednesday, February 15, making it harder for crypto firms to be “qualified custodians.” Qualified custodians are licensed to hold and store digital assets on behalf of clients.

SEC Could Curtail the Coming Together of Traditional Finance and Crypto

For hedge funds, pension funds, and private equity firms to hold crypto assets, they must use the services of qualified custodians. If the rule change is approved, it could mean that institutional funds involved with crypto may have to transfer their funds elsewhere. Bloomberg cites sources familiar with the matter who have indicated that institutional funds may be subject to surprise audits of their custodial relationships. For the rule change to be approved, all five SEC commissioners must approve it and make the proposal available for public comment. After receiving feedback, the agency must consider this and, after that, vote on the rule change again.

The SEC is responsible for protecting investors and ensuring that financial markets remain fair, and in their view, the crypto industry poses a significant threat to achieving its goals. As such, the SEC has launched significant enforcement against numerous crypto firms this year, and its newest move could potentially significantly disrupt the burgeoning crypto market. At the very least, a rule change such as this could curtail the progress made between the traditional finance sector and the crypto industry.

SEC Has Laser Eyes for Crypto – And Not in a Good Way

2022 proved one of the most tumultuous years for the crypto industry. Many major players in the industry collapsed and triggered an ice-cold crypto winter that wiped out $2 trillion from the market. Understandably, regulators have become concerned with preventing events like the collapse of the Terra ecosystem and Sam-Bankman Fried’s crypto empire from occurring again. However, the SEC has become the regulator most concerned with action and enforcement against crypto-related companies it deems a danger to the broader ecosystem.

In the past week, the agency launched action against cryptocurrency exchange Kraken over its staking program. The SEC argued that Kraken’s staking program was an unlawful offer and sale of securities. The agency claims that because the program was an unregistered offering, investors did not have sufficient information regarding the company’s financial condition, fees, and investment risks. The exchange, however, reached a settlement with the SEC in which it agreed to pay $30 million in penalties and agreed to shutter its staking business.  

Days after the news of its settlement with Kraken broke, the SEC announced it intended to sue stablecoin issuer Paxos over Binance USD (BUSD). The agency alleges that BUSD is an unregistered security. After learning of the SEC’s intention, Paxos said it would halt the minting of new BUSD tokens. Earlier today, Paxos said that it categorically disagreed with the allegations made by the SEC and said that its stablecoin did not qualify as a security under federal securities laws. Paxos further said it would engage with the SEC on the matter and would resort to litigation if it becomes necessary.

The SEC must strive to fulfill its duties of protecting investors and ensuring market fairness, so regulating the sector is imperative and understandable. The manner in which the agency takes on its responsibilities and the vigor with which it has done so has become a concern for many. A “targeted attack” and an “anti-crypto attitude” resonate with many.

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.