Grayscale worried the SEC may ban it from using Coinbase

Grayscale Investments is worried that the SEC may prevent it from using Coinbase as the sole holder of $5.4 billion of its crypto assets, according to CEO Michael Sonnenshein.

In a letter to the SEC dated May 8, Sonnenshein complained that the SEC’s proposed new rules around safeguarding custody of clients’ crypto funds would make it impossible for Grayscale to continue storing its bitcoin and ether with Coinbase’s custody arm.

The SEC wants to make investment advisers responsible for safeguarding the custody of assets they control for clients. Such a rule would be a problem for centralized exchanges like Coinbase, or any platform that manages clients’ assets via Coinbase. Exchanges typically hold customer funds in commingled accounts and credit customers for their value, rather than providing an individual wallet for each customer. The SEC’s proposal would make that illegal. The proposal might also ban investors from using a third party to store their clients’ funds.

Grayscale stores $5.4 billion in crypto with Coinbase

Grayscale controls the Grayscale Bitcoin Trust (GBTC) and the Grayscale Ethereum Trust (ETHE), which it claims are the largest crypto funds of their kind. Both hold about $2.7 billion in Bitcoin and ether. 

Currently, the entirety of those funds is held by Coinbase via the Coinbase Custody Trust Company, Sonnenshein told the SEC. The funds have been there since 2019. Coinbase Custody holds Grayscale’s assets in offline cold storage, via unique onchain addresses, and are never commingled with other clients’ funds, according to the agreement between Grayscale and Coinbase.  

Previously, Grayscale stored cold wallets via a company called Xapo Inc. “Xapo’s custody model relied on geographically dispersed physical vault locations around the world, which changed regularly,” he wrote.

The SEC’s proposed rule would upend Grayscale’s entire model for storing its $5.4 billion in client assets, Sonnenshein said. “As an institutional-grade asset manager, we do not ourselves custody client assets. Instead, we engage expert third-party custodians to provide this service, as is the norm for traditional asset managers. In our ten years of operation, our custodians have never experienced a loss of client assets.”

‘None of these custodians have ever reported a loss of client assets’

“Coinbase Custody also uses specific, industry leading practices in its policies, procedures, and controls for safekeeping and maintaining exclusive possession or control over digital assets that it custodies to protect against the theft, loss, and unauthorized and accidental use of the private keys necessary to access and transfer the digital assets it holds in custody.”

“None of these custodians have ever reported a loss of client assets,” Sonnenshein wrote. “In short, the methods that we and others rely on to safeguard client assets work, and we caution the Commission against taking action that would impose significant new costs, risks, and burdens without added benefit.”

Coinbase has also complained about the proposed rule. “The proposal would ban [registered investment advisers] from trading on non-QC [qualified custodian] crypto exchanges,” Chief Legal Officer Paul Grewal said in a tweet yesterday. “This wouldn’t benefit RIAs or their clients and would in fact harm them. Thus the SEC should allow limited non-QC exposure so RIAs can trade crypto for their clients.”

The SEC’s comment period closes this month.

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