This post first appeared in the Government Contracts Blog.
Over the past couple of years, the crypto industry has come under heavy scrutiny from skeptical regulators seeking to root out fraud and protect investors amid the initial coin offering boom that generated over $4 billion in 2017. However, this skepticism is starting to give way to a more business-friendly attitude.
Crypto firms have made notable headway with regulators in recent months, securing authorizations to act as custodians of digital assets and working towards approval of the first bitcoin-based exchange traded fund (“ETF”). These developments may reflect an evolving collaborative environment that bodes well for the future of blockchain-based innovations.
State and federal “custody rules” require that certain financial institutions utilize a qualified custodian, which must comply with stringent procedures to safeguard customer funds. Many firms are working on qualified custodial solutions for crypto assets and their unique technological challenges. However, the industry has been slow to develop, leaving institutional investors without custodians they can trust with the keys to their digital assets.
That may be changing. In September, the South Dakota Division of Banking approved BitGo Trust Company as a qualified custodian of digital assets. On October 23, New York’s Department of Financial Services (“DFS”) followed suit, authorizing Coinbase Custody, an institutional-grade service designed for the secure storage of large amounts of cryptocurrency, to operate as a limited purpose trust company and qualified custodian of crypto assets. DFS requires that limited purpose trust applicants set forth a market analysis, the trust’s purpose, public benefit, physical premises, capitalization, audit procedures, and compliance with Bank Secrecy Act Anti-Money Laundering programs, among other showings.
Crypto firms are also working with federal regulators toward important investment product approvals. Last week, the SEC published a memorandum addressing an October 9th meeting with the Chicago Board Options Exchange (“CBOE”), New York-based investment management company VanEck, and blockchain software developer SolidX (collectively, “VanEck”) to discuss their application to list a bitcoin ETF on the CBOE BZX Equities Exchange.
The SEC incorporated the memo into its digital file reflecting public discourse regarding the application, including more than 1,400 public comments. The memo attached VanEck’s presentation to the SEC, which noted that VanEck plans to issue shares of its VanEck SolidX Bitcoin Trust for about $200,000, or 25 bitcoin, per share.
As set out in VanEck’s presentation, the SEC rejected a prior application in March 2017 as inconsistent with Section 6(b)(5) of the Securities Exchange Act, which requires that exchange rules be designed to prevent fraudulent and manipulative acts and facilitate protected transactions. In an interview this past June, SEC Chairman Jay Clayton explained what his agency is looking for: “We need to know that the pricing is certain, we need to know that the assets are there, we need to know that it’s going to function as our retail investors would expect those products to function.”
VanEck’s presentation cited several important factors it argued alleviated the SEC’s prior concerns, including the existence of successful CFTC-regulated bitcoin derivatives markets, the proliferation of information sharing agreements to detect market abuses, and share prices intended for institutional, not retail, investors. The Trust will carry insurance and use an index of OTC bitcoin trading desks for pricing. Further, as explained in its Form S-1, the Trust will store the private keys to its bitcoin holdings in “cold storage wallets” that reside on computers disconnected from the Internet and other computer networks for enhanced security.
Rather than rejecting this application out of hand, as it has in the past with others, the SEC has twice postponed a decision on VanEck’s renewed bid. The new decision deadline has been set for December 29th. Some view this continued engagement as a promising sign that the SEC is inching closer to a “yes” on the first bitcoin ETF.
These developments show that, while regulators remain focused on ridding the digital asset space of bad actors, they are also starting to demonstrate an openness to greenlight the plans of industry participants who have done their homework.