SEC’s New Crypto Custody Proposal Leaves DeFi Vaults In Limbo, Bitwise Counsel Says

Bitwise General Counsel Johanna Collins-Wood said vaults running on smart contracts fell outside a rule written around wallets and addresses.

• Bitwise's general counsel welcomed the SEC's custody proposal on Friday, but said DeFi questions were not resolved.
• Managers could hold assets themselves where no qualified custodian would take them.
• The Securities and Exchange Commission was taking comments for 60 days after the proposal reached the Federal Register.

Bitwise General Counsel Johanna Collins-Wood said that the Securities and Exchange Commission's (SEC) new crypto custody proposal solved problems asset managers have faced for years, but that "important questions about DeFi still remain[ed]."

Collins-Wood explained her reading of the custody counsel on X on Friday, saying that the framework "thoughtfully addresses problems crypto asset managers have faced since 2017". She added that it was encouraging to see the SEC working through the issues with the industry, while voicing her approval of the path to holding assets directly.

"For years we have dealt with the issue of wanting exposure to a new token that no qualified custodian would hold," Collins-Wood said.

The proposed Rule 223-1(b)(7) would allow self-custody in that situation, subject to controls, reporting, and other safeguards, with managers required to move the asset once a qualified custodian becomes available.

Collins-Wood also pointed to the recognition of state trust companies as crypto custodians, clarified trading authority and standing letters of authorization, and permission to keep records on-chain. Those, she said, are "practical changes that provide practical solutions."

Vaults Fall Outside The Rule

However, she had one point of difference. Collins-Wood said the proposal rested on an assumption that did not hold across all through the crypto industry.

The framework was built around wallets and client addresses, she said, which did not describe how decentralized finance worked.

What Did The SEC Propose?

The commission proposed new rules on Thursday to establish a tailored framework for how registered investment advisers and regulated funds could custody certain crypto assets and offer crypto investments. This also includes potential pathways for self-custody.

The proposal would also authorize state trust companies to act as custodians, update audit requirements for advisers, modernize broker-dealer custodial standards for funds, and remove barriers to giving crypto-related investment advice.

Chairman Paul S. Atkins added that the rules "would provide a clear regulatory framework for the custody of crypto assets, giving investment advisers and funds a compliant pathway," replacing what he called "the grey of uncertainty created by custody rules crafted for a bygone era."

According to Bitwise’s Collins-Wood, the SEC was inviting discussion on the gap she identified, through questions 171 to 180 covering DeFi, staking and receipt tokens. Comments are due 60 days after publication in the Federal Register.

Vaults Draw Institutional Interest

These developments come as large firms have been looking at the products the rule did not describe. Morgan Stanley (MS) said on Tuesday that it had set up a Digital Asset Lab partly to test DeFi vaults, with its digital assets head calling them an area of particular interest while cautioning that the technology was “too nascent to risk the firm's wider platform.” 

The proposal also arrives weeks after the Digital Asset Market Clarity Act (CLARITY Act) failed to advance in the Senate last month, leaving regulators to set the terms through rulemaking rather than legislation.

Bitcoin Slips As ETF Demand Holds Steady

Institutional demand has held up through the week. Spot Bitcoin ETFs drew over $102 million on Thursday, the day the proposal landed, and roughly $120 million the following day, according to SoSoValue data.

Bitcoin’s price was down nearly 2% during the past 24 hours. On Stocktwits, the retail sentiment around BTC moved to ‘bearish’ from ‘neutral’ while chatter around it shifted to ‘normal’ from ‘low’ over the past day.

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