TRANSCRIBED FROM: https://www.adamtracy.io/video/cryptocurrency-custody-rule/
So, crypto custody, crypto custodians, it’s a weird thing, because you’ll find thousands of them out there. But all but maybe three, do what they purport to do. And the concept of custody, right, comes from the securities and futures world and in particular, the investment advisors act of 1940, right? And that requires investment advisors to use a qualified custodian. And that qualified custodian is typically a bank, registered trust company, broker dealer, futures merchant or, uh, uh, some type of state sanctioned trust of custodian, right? There’s very few out there that actually can offer their services or do offer their services to crypto platforms. Crypto advisors, right?
And, you know, first the l- the rule applies to investment advisors only. So, if you’re exempt from investment advisor registration, which I spoke about here before, right, which generally speaking amongst other exemptions is having assets of under 150 million or less, you don’t have that same rule or obligation to use a qualified custodian. You can engage in self custody, which you, sort of, bear the risk of that, right, as it relates to the safeguarding of your clients’ assets.
But it brings us two interesting questions. One, if you are, in fact, an investment advisor and you have to adhere to the custody rule, where do you go? Right? And there’s very few options out there. But more importantly, the unanswered question is as a crypto exchange. Right. Like a coin base crack and you name it, easily have assets under management altho- albeit not actively managed in the realm of 150 million and up. So, the custody rule would seemingly apply. Because again, crypto exchange is nothing but a state level money transmitter, right? So, the question becomes what service are they actually providing? Are they acting as an investment advisor?
And part of that inures part of the answer to that question inures to what’s being traded, right? Bitcoin we know is a commodity. So are they acting as a commodities trading advisor, which thk- to which the custody [inaudible 00:03:20] would also apply. Right, and you’d have to find a futures broker. Um, if they’re handling security tokens, are they then an investment advisor? Arguably they are, but few exchanges are in, at least in the United States are utilizing qualified custodians for their operations, right? Everything’s held at the exchange level.
Now, Coinbase and BitGo and some other have sought to purchase broker dealer licenses and go in that direction, become qualified custodians themselves, which is the right thing to do. But, you’ve got 24-odd US exchanges and you just don’t see this happening. So, the question is are they app- you know, uh, outside of the myriad of questions, right, are they acting as a national securities exchange, which, you know, we’ve discussed before and all that. Are they acting as investment advisors but not following the custody rule? And then obviously not also registering as an investment advisor.
So, it’s an interesting concept and it’s a huge hole in the market, right? There’s a huge hole in the market because there’s just simply not enough qualified custodians to handle what arguably [inaudible 00:04:33] volume and as you see hedge funds, crypto-backed hedge funds, base hebge- hedge funds increase in value and more and more larger players getting into the market, the need for this custody becomes essential because they’re going to surpass f- 150 or they’re gonna be registering investment advisors to begin with.
So, it’s, um, an interesting conundrum and it’s an unsolved and unmet need in the marketplace to a large extent and there’s some, again, there’s some qua- like, prime trust and others are very good and qualified to do it, but on a grander scale to take the market to the next level as a legitimate financial services sector, right, that’s what you, you’re lacking. And you have again this uncertainty that falls beck onto the legitimacy of crypto exchanges as to whether or not they should be using qualified custodian for what they’re doing and conceivably if you did, maybe you don’t have, you know, the large seh- scale hacks, right? Maybe these done occur. Maybe they do, maybe they don’t. You know, who knows? It’s all about the custodian and to what extent the custodian is safeguarding assets.
But the question that’s left unanswered and I think needs to be answered by arguably the SEC and the CFTC is the legal status of these exchanges, right? And to what extent they do or do not need to follow the custody rule amongst other rules, because right now, they’re just a creature of very banal, very easy, lightly regulated state law with perhaps the exception of bit license in New York.
So, that’s my, uh, that’s my take for the day. Uh, if you have any questions regarding custody or need referral to a good custody company, feel free to hit me up adam@adamtracy T-R-A-C-Y.io. Happy to always answer any questions that you have. Cheers.
A former professional rugby player, Adam S. Tracy brings over twenty years’ experience as an attorney, consultant and dealmaker with a particular focus on cryptocurrency, digital products, payments and immersive corporate structures. As an accomplished executive and advisor to high risk merchants and stakeholders, Adam has proven himself as a results oriented, decisive leader with proven success advising early market entrants, technology adapters, as well as established participants across a wide range of verticals. Adam Tracy’s attack-first personality allows him to excel in dynamic, demanding environments including complex corporate negotiations, distressed environments and regulatory investigations.
In addition, Adam S. Tracy also has a successful track record co-founding high risk industry ventures, building & leading cross-functional teams, and spearheading diverse corporate transactions. A serial entrepreneur, Adam has successfully started and created exits across a wide swath of markets, including various mobile SaaS ventures, nutraceuticals, peer-to-peer payment systems, and several telemarketing-based ventures. Moreover, as a recognized expert in the payments field, Adam Tracy has been a blockchain and digital currency evangelist and influencer since the early days of Bitcoin.
Utilizing his proprietary “Pre-Event Driven™” strategy for decision making, Adam S. Tracy further leverages his over twenty years’ experience to create cost-effective, value-add solutions for each client. A data-driven acolyte, Adam continually refines his strategies based on field studies and data collection. Moreover, Adam Tracy further augments his range of solutions by actively networking with regulators, liquidity providers, legal and compliance experts, deal-flow brokers, investors and management of leading high risk industry ventures.
Adam S. Tracy earned his Bachelor of Science in Computer Applications and Bachelor of Science in Finance from the University of Notre Dame. He subsequently earned his Masters in Business Administration from the DePaul Kellstadt Graduate School of Business, while concurrently earning his Juris Doctorate from the DePaul College of Law. Adam lives outside Chicago with his with his wife, four dogs, and two cats.
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