U.S. SEC Takes Preliminary Step to Expand Universe of Crypto Custody to State Trusts

Executive Summary

The U.S. Securities and Exchange Commission (SEC) has signaled a notable shift in its approach to digital asset custody. The SEC's Division of Investment Management issued a no-action letter, allowing registered advisers and funds to utilize state-chartered trust companies for the custody of crypto assets. This decision broadens the available options for institutional crypto custody by treating these entities as "banks" under the relevant custody provisions of the Investment Advisers Act of 1940 and Investment Company Act of 1940. This move is part of a broader "crypto-forward campaign" under the current SEC leadership, aiming to provide clearer regulatory guidance and foster greater institutional participation in the digital asset market.

The Event in Detail

The no-action letter, issued by the SEC's Division of Investment Management, addresses a long-standing question regarding the eligibility of State Trust Companies as permissible custodians for crypto assets. Historically, registered advisers and regulated funds faced uncertainty regarding whether their chosen crypto asset custodian met the definition of a "bank" under the Investment Advisers Act of 1940 and Investment Company Act of 1940. The staff's no-action letter clarifies that it would not recommend enforcement action against registered advisers or regulated funds for maintaining crypto assets and related cash equivalents with certain state-chartered financial institutions, provided they operate within a robust regulatory framework.

This development contrasts with previous SEC stances, particularly those under former Chairs Gary Gensler and Jay Clayton, which were generally more restrictive regarding crypto asset activities. A significant preceding factor was the repeal of Staff Accounting Bulletin (SAB) 121 and its replacement with SAB 122. SAB 121 had mandated that financial institutions offering crypto custody services recognize a safeguarding liability and corresponding asset on their balance sheets, imposing substantial regulatory capital requirements that discouraged many banks and broker-dealers from offering these services at scale. SAB 122 rescinded this interpretive guidance, allowing financial institutions to adhere to established accounting standards from the Financial Accounting Standards Board (FASB) or international guidelines, thereby broadening their ability to provide crypto-related services.

This regulatory clarity is expected to benefit trust affiliates of prominent crypto firms such as Coinbase and Kraken, enabling them to offer expanded custody services to regulated entities. However, the decision has not been met with universal approval within the SEC. While Commissioner Hester Peirce has expressed support, Commissioner Caroline Crenshaw has voiced strong opposition, citing concerns about inadequate market oversight, procedural issues, and a potential degradation of investor protection. Crenshaw argued that the decision creates "holes" in the existing custody framework and questions why crypto assets might receive less robust custodial protections compared to traditional assets.

Market Implications

The SEC's no-action letter directly impacts the financial mechanics of digital asset custody. It does not expand the statutory definition of a permissible custodian but provides a staff position that State Trust Companies, under appropriate regulatory frameworks, can be considered permissible. This regulatory clarity is crucial for reducing compliance risks for registered advisers and funds seeking exposure to crypto assets.

Combined with the rescission of SAB 121, which removed significant balance sheet hurdles for financial institutions, this move is poised to substantially broaden institutional participation in the crypto market. By increasing the number of qualified custodians, the development is expected to foster greater adoption and legitimization of digital assets within traditional finance. Furthermore, the Office of the Comptroller of the Currency (OCC) issued Interpretive Letter (IL) 1184, clarifying that banks may buy, sell, and outsource crypto-asset activities, including custody, subject to appropriate risk management. This aligns with the broader trend of easing regulatory burdens for financial institutions engaged in crypto services.

The potential impact on the broader Web3 ecosystem includes enhanced liquidity, increased trust, and improved access to digital asset investments for institutional clients. While the clarity is seen as positive for institutional adoption, internal dissent within the SEC, as expressed by Commissioner Crenshaw, introduces a degree of uncertainty regarding potential future regulatory shifts or legal challenges.

Expert Commentary

Paul Atkins, the current SEC Chairman, has explicitly stated that cryptocurrency is the agency's top priority. He emphasizes a strategic pivot from a primary focus on enforcement actions towards proactive policy development, aiming to foster innovation within the crypto sector. Atkins asserts that clear regulatory frameworks are indispensable for ensuring market fairness and preserving the United States' global competitiveness in finance.

Commissioner Hester Peirce, a long-standing advocate for the digital asset sector, leads the newly established SEC Crypto Task Force. This task force is dedicated to developing a comprehensive and transparent regulatory framework for crypto assets, with a stated mission to regulate "less through enforcement" and more through established guidelines. Peirce's support for the no-action letter aligns with her consistent push for regulatory clarity conducive to innovation.

In contrast, Commissioner Caroline Crenshaw voiced strong objections to the no-action letter. She criticized the move for potentially "degrading" the existing custody framework, highlighting what she perceives as a lack of adequate oversight for the nascent crypto markets and procedural issues. Crenshaw expressed concerns that this action could expose investors to increased risks of theft, loss, or misappropriation, questioning the rationale behind offering crypto assets potentially lesser custodial protections compared to traditional financial assets.

Broader Context

The SEC's no-action letter is situated within a broader governmental and regulatory shift towards digital assets. The Trump administration has initiated steps to reverse previous approaches, issuing an executive order, "Strengthening American Leadership in Digital Financial Technology," which advocates for a more pro-innovation stance and clear regulatory guidance. This marks a philosophical departure from the prior administration's emphasis on risk mitigation.

The establishment of the SEC Crypto Task Force, announced by Acting Chair Mark T. Uyeda and led by Hester Peirce, underscores the agency's commitment to developing a comprehensive regulatory framework. The task force aims to streamline regulatory processes and provide clear pathways for crypto asset registration, moving away from an enforcement-centric model.

Furthermore, there is a concerted effort towards inter-agency collaboration. The SEC and the Commodity Futures Trading Commission (CFTC) are working together on initiatives such as Project Crypto and the CFTC Crypto Sprint to enhance digital asset regulation and minimize fragmented or overlapping rules. Complementing these federal actions, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) have withdrawn previous supervisory guidance and joint statements concerning crypto-asset activities for banks, further aligning the regulatory landscape towards greater accommodation for digital assets within the traditional financial system.