Oct. 29, 2023
Ignoring Global Best Practices - The Proposed Rule ignores global best practices for cryptoasset custody, threatening U.S. leadership in financial innovation. The SEC should provide flexibility for proven crypto custodians to qualify under appropriate regulation. Blockchain technology enables novel methods to definitively prove custody and prevent loss or theft. Private keys provide mathematical proof of ownership and control of cryptoassets. When implemented properly, multiparty computation cryptographic protocols allow custodians to maintain fractionalized private keys while still guaranteeing provable, exclusive control. See Protocol Labs Research Papers at https://protect2.fireeye.com/v1/url?k=31323334-50bba2bf-3132d782-4544474f5631-dfa07984a718e6db&q=1&e=ac6ad9c0-b0d7-4ed7-9283-2c52ca8af13c&u=https%3A%2F%2Fresearch.protocol.ai%2Fpublications%2F. Protocols like threshold signatures, secret sharing, and distributed key generation have been developed specifically to address cryptoasset custody challenges. Top crypto custodians use these methods to eliminate single points of failure and reduce hacking risks. The Proposed Rule disregards technical innovation in cryptocustody. It narrowly defines "control" based on legacy concepts of possession developed for traditional assets. This ignores mathematical guarantees provided by properly implemented cryptography. Other jurisdictions such as Switzerland, Singapore, and Japan have taken more open, technology-neutral approaches to regulating cryptoasset custody. Ignoring global best practices will push U.S. cryptoasset innovators overseas and surrender America's leadership in financial technology. Rather than prohibit innovative technical solutions, the SEC should establish functional custody requirements addressing: (1) isolation of customer assets, (2) transaction transparency, (3) transfer authorization controls, and (4) contingency planning for key loss or compromise. Technical standards could be adapted from other jurisdictions or developed in collaboration with industry. Outcomes, not methods, should determine whether custody is "qualified." This principle-based approach would allow proven custodians utilizing the latest cryptography to qualify while excluding inadequately secured platforms. It would foster American leadership in financial innovation based on excellence in technology and regulation. The SEC should reconsider its overly narrow custody requirements. With appropriate regulation of new technical solutions, cryptoasset custodians can provide security and proof of control exceeding that for traditional asset custody. The U.S. should embrace and encourage such innovation. Stubbornly clinging to the past will only drive cryptoasset custody.