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New York releases guidance to protect crypto users’ funds

The New York Department of Financial Services (NYDFS) has announced a raft of regulations to protect crypto firms’ customers in the event of insolvency.

The Superintendent of the New York State Department of Financial Services (NYDFS), Adrienne A. Harris, has released regulatory guidance on custodial structures for customer protection in the event of insolvency for crypto market participants.

Aiming to protect customers in the event of an insolvency or FTX-type collapse, the guidance emphasizes the “paramount importance of equitable and beneficial interest always remaining with the customer.” The release also pinpoints sound custody and disclosure practices to offer protective parameters to customers.

The Superintendent directed the publication to entities licensed New York banking law that custody virtual currency assets.

NY official notes that virtual currency entities and custodians play an essential role in the financial system. Hence, they raise a need for a comprehensive and safe regulatory framework. The regulator opines that such a framework would play the vital role of protecting customers and preserving trust.

One of the critical issues the updated guidance addressed was the segregation and separation of customers’ crypto assets. According to Harris, crypto companies and exchanges operating in New York must separate company funds from users’ crypto holdings both on-chain and in the company’s “internal ledger accounts.” The regulator expects crypto companies to hold customers’ assets only to provide custody and safekeeping services rather than create a debtor-creditor relationship.

In addition to the issue of commingling funds, the regulator also insisted crypto companies disclose the terms and conditions of their products and services to prospective customers, including how they account for crypto assets.

Finally, the DFS guidance also addressed sub-custody arrangements with third parties. It stressed the need for crypto firms to conduct appropriate due diligence before entering such agreements and ensure they are consistent with NYDFS guidelines.

The post-FTX digital assets scene

Following the crypto-space-shaking implosion of Sam Bankman-Fried’s FTX crypto empire, crypto investors and traders are becoming increasingly wary of centralized exchanges. From being labeled a fraud to losing the support of investors and celebrities, the formerly popular exchange FTX has given a grave lesson to players, regulators, and onlookers in the Web3 space.

Over the years, interest in digital assets has grown, but the FTX saga raised awareness and painted the space in a scary light. It is, therefore, no surprise that this guidance addresses custody, trying to protect the customers and their assets.

The guidance is the most recent in a series of crypto-related directives issued by the NYDFS in the past year. The agency is widely regarded as one of the most stringent and well-respected crypto regulators in the United States. Nonetheless, its reputation lends significant credibility to those companies operating under its purview.

Earlier this month, the NYDFS revealed it had reached a $100 million settlement with Coinbase over the crypto exchange’s failure to comply with anti-money laundering regulations. This followed a $30 million fine imposed by the agency on Robinhood Markets for alleged violations of anti-money laundering, cybersecurity, and consumer protection rules.

This article was written in collaboration with Julius Mutunkei.

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