preface
What is lacking in the field of digital assets is not a strict or loose framework, but the lack of a clear boundary between legal and illegal.
It has been 12 years since Satoshi Nakamoto released the Bitcoin white paper. Digital assets such as Bitcoin and Ethereum have gradually gained a place in the minds of the public. In the past year, the federal government’s legal exploration of digital assets is accelerating. On March 9, 2020, at the beginning of the outbreak, the federal government introduced the “Encryption Currency Act 2020″[1] to clarify the power to supervise digital assets. To this day, we can clearly feel that the enthusiasm of the digital asset market has promoted the accelerated improvement of the law.
·This fall, the U.S. Office of the Comptroller of Currency began to pay attention to the compliance of digital asset business, and the first licensed digital asset bank appeared;
·The Wyoming state government’s active deployment of the regulatory framework for digital asset banking and custody business has made it attract the attention of the federal government;
·The SEC began to look for qualified “digital asset banks”, and “old players” such as Coinbase and Grayscale were eligible;
·Recently, the U.S. government has frequently issued policies and the compliance process has accelerated, which indicates that the digital asset market is experiencing “adolescence.”
Can digital assets be hosted?
In the traditional financial field, the asset custody business usually refers to a commercial bank with certain qualifications as the custodian, in accordance with relevant laws and regulations, signs a contract with the client, safe custody of client assets, collects custody fees, and provides Investment management and other services.
In the United States, such traditional custody companies usually include trust companies, securities custody companies and banks.
When it comes to digital asset custody business, similar to traditional financial methods, the customer’s digital assets such as BTC and ETH are handed over to a centralized institution for safekeeping, just as customers store precious metals in a bank vault. It’s just that the way of storage is slightly different. The custody of digital assets is often stored in the cold/hot wallet of a centralized exchange. A cold wallet is a storage device that is not connected to the network like a hard disk, and stores the customer’s public key and private key (similar to a bank card number and password). Cold wallets are generally offline.
The security of assets is a core consideration for users when choosing a custodian or service. Asset management experience, institutional credit, and the strength of treasury security are all key factors to be investigated. The offline cold wallet mechanism mentioned above is an effective measure to ensure the security of digital assets.
As the market value of the digital asset market continues to rise, the demand for digital asset custody has also risen. When the scale reaches a certain level, non-compliant institutions as the main players of hosting will bring huge potential dangers to the market. In order to avoid hidden dangers planted by lack of compliance, the government will naturally pay more attention to this field.
In the United States, at least 10 states have issued warnings on digital asset service businesses, of which custody is the top priority. However, different state governments have different attitudes towards digital assets. Some state governments have shown a very positive attitude, while others are not. Some states have even banned digital assets as a means of payment.
Wyoming is a state with a more positive attitude. The state government seems very optimistic about the future development of digital assets. Many institutions have been approved by the Wyoming State Legal Department to become compliant digital asset service providers. Wyoming is the least populous state in the United States. None of the 30 banks in the state has a total deposit of more than $1 billion, and there is no foreign bank. At the same time, the tax environment in Wyoming is very relaxed, because it is “small” and has a higher degree of flexibility in the framework of emerging industries. Here, the loose regulatory environment is more like a laboratory for the digital asset market. The state government also has ambitions to open up new markets, and appreciates those “forward-looking” emerging companies that are not tied to Silicon Valley, New York and other regions. [2]
“Because our legislation is small and very flexible, this has made Wyoming unique in this emerging field…. People have always expected innovation to come from New York or California, and now we can be the first mover. And we The challenge is how to stay ahead.”
The U.S. Office of the Comptroller of the Currency, OCC, allowed the National Bank to provide digital asset custody services in mid-July 2020. In September and October, Kraken Financial* and AvantiBank* successively obtained the authorization of the “digital asset bank” in Wyoming, becoming the first and second digital asset “new bank”. [3][4]
*Note: Kraken is a veteran digital asset exchange established in the United States in 2011 and provides price information to Bloomberg terminals; the founder and CEO of AvantiBank is an active advocate of the blockchain industry in Wyoming.
Prior to this, only some trust companies and large mutual fund companies such as Fidelity Investments were able to custody digital assets in compliance.
Such a transformation has accelerated the complementary effects of enterprises and governments. Since the fall, the digital asset custody business in Wyoming seems to have made a lot of progress.
The “New Bank” of the Wyoming State Banking Department
Wyoming tried to develop the industry through preferential conditions for establishing laws and regulations in the field of digital assets, and then stimulate the economic development of the state. The bill intends to achieve compliance with the digital asset custody business of private enterprises by establishing a “new type of bank”.
On October 23, 2020, the Banking Department of Wyoming, the United States issued a “No Prosecution Opinion Letter” [5]. It claims that it has included a trust institution “Two Ocean Trust” on the list of “digital asset custody business qualified persons” in accordance with the laws and regulations of Wyoming State, allowing it to provide digital asset custody services. This company is different from Kraken and Avanti. This company is an asset management company.
The letter pointed out that although Two Ocean is an asset management agency, it meets the definition of “bank” in the 1940 Advisers Act. The bank has been licensed to operate digital asset custody business. Become a “qualified custodian” under the SEC’s Custody Rule. That’s why Two Ocean’s compliance was created, which was the first asset management company to become a compliance custodian.
The most important thing is that an asset management institution that meets the definition of a “bank” can be counted as a “qualified custodian”, but what kind of asset management institution can be counted as a “bank”? The letter aims to provide explanatory guidance on this key part of the “Custody Rules.” In short, the organization must meet four key elements:
·Under the US regulatory legal system;
·The deposit and custody business used should be similar to that of banks in the U.S. regulated by OCC, and these businesses must be the main business;
·The company must be regulated by the state or federal bank deposit system;
·Cannot violate federal securities laws.
According to this definition, the law favors banks as qualified custodians rather than state-level asset management or trust companies, because most asset management or trust institutions have difficulty meeting the above definition.
Immediately afterwards, on November 9, 2020, the US Securities and Exchange Commission SEC responded to the letter: saying that it is looking for institutions that can become “qualified digital currency custodians”[6]. They are particularly interested in the following points of “Qualified Custodians”:
·Does the licensed trust company have similar characteristics to the financial institution determined by the committee as a qualified custodian? If so, to what extent?
·How is the custody service provided by a licensed trust company the same or different from that of a bank, broker or futures dealer? If a licensed trust company acts as the custodian of the client’s digital assets or other assets, what aspects of protecting client assets and strengthening security may be vacant?
·How can a consultant assess whether a custodian is qualified according to the “SEC Custodian Rules”? What qualities do consultants value when looking for qualified custodians? Do these qualities change with different asset classes? In short, compared with the custody of other assets, what special qualifications are required for custody of digital assets? why?
·Are there any institutions that meet the definition of the “SEC Custodian Rules” but cannot be counted because they have not met the policy objectives? Conversely, are there any organizations that have been included but have not met the rules?
On the whole, the SEC’s attitude towards this letter and the “new bank” mentioned in the letter is both positive and cautious. The custody of financial assets itself is a legal problem, especially when traditional assets and digital assets are parallel, the legal system is difficult to improve. The term “custodian” is often abused, and there are not a few institutions that take advantage of existing legal loopholes. Therefore, clear definitions and responsibilities are indeed a top priority for financial regulators.
What are the advantages of Coinbase and Grayscale?
Grayscale and Coinbase, which have multiple compliance qualifications, have higher credit endorsements than other peers.
Coincidentally, Coinbase Custody also meets the “qualified custodian” requirements defined by the SEC, and is currently serving Grayscale, hosting most of its digital assets. As the largest digital asset management company, Grayscale has two products that meet the conditions: Grayscale Bitcoin Trust (GBTC) and Grayscale Ethereum Trust (ETHE). At present, all BTC and ETH received by Grayscale are stored in Coinbase’s cold wallet.
The agreement between Coinbase Custody and Grayscale also highlights the fact that Coinbase Custody is only the trustee of custodial bitcoins, and Grayscale as a customer is always the owner of the assets. It is important to understand this, because Coinbase Custody holds Bitlicense* in New York, is chartered as a trust company, and acts as a trustee by exercising its trust rights with Grayscale. Legally managing Grayscale’s digital assets increases the company’s credibility.
*Note: The Bitlicense[7] issued by the New York State Department of Financial Services NYDFS allows the holder to store, hold, maintain, or buy and sell digital assets in New York State (including NYC) on behalf of others.
Coinbase Custody emphasized its commitment under this charter and its degree of compliance as its custodian. According to a Coinbase Custody spokesperson, “…our qualifications as a limited liability trust are chartered and supervised by (NYDFS), which reinforces Coinbase’s commitment to maintaining the highest security and compliance standards. Coinbase Custody is awarded SOC1 The only digital asset custodian that meets SOC2 compliance requirements.”
Regarding what Coinbase does, the key lies in the definition amended by the SEC, that is, a qualified custodian can be someone who is “customarily” used to custody digital assets, that is, if they have always been a custodian, they are now more likely to meet ” Definition of “Qualified Custodian”. This applies to both Bakkt, a Bitcoin futures company, and Coinbase, a Grayscale Bitcoin Trust. It seems that these companies are “old players” in custody of digital assets. And now they are all recognized by national regulatory agencies. Looking at it this way, compliance seems to have really increased.
The credit endorsement brought by compliance has added to the premium to some extent, and it also partially explains why investors choose Grayscale’s GBTC product instead of simply holding BTC.
Under the unified system of “ambiguity”, different state governments have their own trends
At the federal government level, most of the focus on the regulation of digital assets is still on the institutional and administrative levels. Although each institution has a high degree of participation, it lacks formal rulemaking. Federal agencies and policy makers have already expressed their recognition and appreciation for distributed technology, saying that it is an important part of the future infrastructure of the United States, and they also require the United States to maintain a leading position in the development of this technology.
At the state level, some state governments have passed some laws that affect the digital asset industry, mostly at the legislative level. Generally speaking, there are two kinds of regulatory attitudes at the state level: the first is a positive attitude, trying to develop the industry through preferential terms of laws and regulations, and then stimulate the economic development of the state. Wyoming is the best example. The second attitude is relatively conservative. Before the emergence of a complete system, it chose to prohibit the use of digital assets as a means of payment, such as Colorado (Maryland and Hawaii also issued investment warnings).
Companies under the Digital Currency Group, such as Grayscale and Coinbase, have the potential to become qualified compliance custodians because they are the “founding fathers” of the digital custody industry.
The establishment of the MSB regulatory network* also marks the day when a nationwide unified standard has arrived. Although it is not very mature, traditional financial services are still used as a model reference, but the compliance process has made considerable progress so far.
*Note: Currently in the United States, if you want to legally operate digital asset services, you must first register as a money service business (Money Services Businesses, MSB) and receive the federal law’s supervision of MSB; next, you need to hold a Bitlicense, The business license of NY and other digital currency service businesses can legally provide services such as trading or custody of digital assets. According to TokenInsight’s survey, the cost of obtaining a national license through a license intermediary is $176,226, plus an annual fee of $136,855.
The digital asset market is experiencing “adolescence”
The digital asset market is experiencing a “puberty” in terms of market value and policy. While growing rapidly, you will inevitably encounter stumbling and frustration. The key is whether the “visible hand” can play a role in correcting crookedness.
Gu Yanxi, founder of Liyan Consulting, once said: “The future digital financial ecosystem is an ecosystem based on distributed accounting technology that uses digital currency for daily payments and digital currency transactions of digital assets.”
Fortunately, SEC Chairman Jay Claton will end his term at the end of this year. During his reign, he strictly classified various types of “Crypto Asset” into two categories: instrument and securities. Therefore, all digital assets classified as securities must be strictly controlled by the securities law, which in turn leads to digital assets. The development of securities properties is slow.
At the same time, OCC has always been very active in the layout of digital assets. On November 17, 2020, President Trump nominated the former chief legal officer of Coinbase, Brain Brook, as the next OCC chairman.[8] If passed by Congress, the “Crypto-Friendly” chairman will come to power in early January next year. In the second place for 5 years. Timely follow-up of the system and close supervision and guidance are of great help to the digital asset industry. This may bring major innovations to the regulation of digital assets.
