NYDFS Releases Guidance to Protect Crypto Customers‘ Funds

• The New York Department of Financial Services (NYDFS) recently released guidance on custodial structures in order to protect customers‘ money in the event of a crypto firm bankruptcy.
• The guidance stresses that businesses should not commingle customer funds and that customer funds should be segregated with separate accounting.
• The NYDFS guidance provides a summary of four different policies and standards that virtual currency entities (VCEs) should adhere to, including segregation of and separate accounting for customer virtual currency, VCE custodian’s limited interest in and use of customer virtual currency, sub-custody arrangements, and customer disclosure.

The New York Department of Financial Services (NYDFS) recently released guidance on custodial structures in order to protect customers’ money in the event of a crypto firm bankruptcy. The guidance comes after the recent collapse of FTX and allegations directed at its co-founder, Sam Bankman-Fried, and top deputies. The guidance was issued by Adrienne Harris, the superintendent of the NYDFS, and the regulator insists that virtual currency custodians need to apply a “safe regulatory framework” to protect customers and preserve trust.

The NYDFS guidance provides a summary of four different policies and standards that virtual currency entities (VCEs) should adhere to in order to properly custody customer virtual currency and maintain appropriate books and records. The four policies are as follows: Segregation of and Separate Accounting for Customer Virtual Currency, VCE Custodian’s Limited Interest in and Use of Customer Virtual Currency, Sub-Custody Arrangements, and Customer Disclosure.

The first policy, Segregation of and Separate Accounting for Customer Virtual Currency, states that customer virtual currency must be segregated from the corporate assets of the VCE custodian and its affiliated entities, both onchain and on the VCE custodian’s internal ledger accounts. The second policy, VCE Custodian’s Limited Interest in and Use of Customer Virtual Currency, instructs VCEs to ensure that customer virtual currency is only used for purposes that benefit the customer, such as to facilitate a customer’s transaction or to settle customer obligations. The third policy, Sub-Custody Arrangements, requires VCEs to only enter into sub-custody arrangements with entities that are subject to similar regulatory requirements and are of comparable financial strength. Finally, the fourth policy, Customer Disclosure, requires VCEs to provide customers with clear and concise disclosure about the details of their custodial services.

The NYDFS guidance is an important reminder that businesses must take appropriate measures to protect customer funds and ensure that customer funds are properly segregated and accounted for. By adhering to the four policies outlined in the NYDFS guidance, VCEs can help protect customers’ money and ensure that customer funds are safe.