NYFDS adopts new rules on proper handling of customer crypto funds

The New York Department of Financial Services (NYDFS) has imposed new rules on crypto companies concerning the appropriate handling of customers' digital funds.

Per an open letter by the NYDFS, crypto firms must separate customer assets, arrange how custodians manage the funds and maintain appropriate disclosures when holding clients' digital assets.

The new guidelines apply to crypto companies operating in New York and licensed by BitLicense — a license issued by New York authorities since 2015 to any business entity involved in digital asset activities.

"As stewards of others' assets, virtual currency entities that act as custodians [...] must have robust processes in place, akin to traditional financial service providers," the NYDFS said in the letter.

The financial agency said it had performed a "robust analysis of the existing regulatory landscape," analyzed market trends and conducted discussions with crypto industry actors and other regulators to develop the new guidelines.

Although the new set of rules is relatively straightforward, BitLicense's reputation among the crypto community is controversial. Several crypto figures, including Kraken CEO Jesse Powell, have criticized the license over the years.

BitLicense's establishment forced Powell to pull out Kraken from the state in 2015. Powell said the regulation hampered the development of the digital asset industry.

"After all this time, I mean, if we just looked back and did a study of the economic damage done by the BitLicense, I'm sure it would be tremendous—in the billions of dollars," Powell said on a podcast.

Custodian's role in new rules

The new crypto regulation in New York emphasizes the importance of asset custodians in the crypto industry. In a financial system, custodians bear the task of keeping customer assets, whether funds or stocks, in a safe and organized way.

According to the new guideline, custodians must keep digital assets that do not belong to them separate from their own assets. The regulator advises custodians to maintain proper records of the assets, both on-chain and in the institutions' internal books.

The new rules also require custodians to hold digital assets only for safekeeping. While safeguarding the assets, NYDFS said that they should not "thereby establish a debtor-creditor relationship with the customer."

New York authorities also require custodians to provide written disclosures to customers that specify the custodial arrangements. It includes how the institution separates virtual assets kept in its custody and how each customer maintains the property interest in those assets.

Demand for regulation

The new rules come as New York prosecutors investigate the implosion of the crypto exchange FTX. The exchange's founder and former CEO, Samuel Bankman-Fried, allegedly transferred billions of dollars worth of FTX customer funds to prop up its trading company, Alameda Research.

FTX's collapse sends a wave of demands for tighter regulations in the crypto industry. Last year, for example, a bipartisan bill — promoted by Democratic Sen. Elizabeth Warren and Republican Sen. Roger Marshall — was proposed to implement the Anti-Money Laundering policy in the industry.

The crypto industry underwent a prolonged volatile period last year due to the unstable global economy. Investors generally avoid riskier assets like crypto, causing significant drops in various digital tokens and failures in many crypto projects.

Several crypto companies went bankrupt in 2022 for various reasons, including the lack of liquidity, as demonstrated by FTX. The failures of high-profile crypto forms, and their alleged unethical business practices, caused investors to lose confidence in the industry. Numerous institutional investors notably pulled out money from the crypto market.

Since New Year, however, the crypto industry has been on a rally. Bitcoin and Ether, the two largest tokens in the market, have posted significant growth in recent weeks. Analysts predict that the gains will stimulate other tokens to start their own rallies.