21st July 2023 > > Nasdaq and US regulation.

tl;dr

Nasdaq has some disappointing news. New US crypto regulation is very welcome.

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Curious Cryptos’ Commentary – Nasdaq

I have some disappointing news for crypto enthusiasts.

Nasdaq had previously announced its intention to build a crypto custody service for institutional clients (https://www.curiouscryptos.com/post/29th-march-2023-nasdaq).

Do not underestimate the importance of custodial solutions for the wholesale adoption of cryptos. CEO Adena Friedman (a surname with unfortunate connotations) said on an earnings call that the slated Q2 launch has been cancelled "considering the shifting business and regulatory environment in the U.S."

Other firms such as Fidelity already provide this service. Nonetheless it is concerning that Nasdaq is fearful of the regulatory climate – its senior execs are overly familiar with the process of negotiating their way through regulatory minefields. The only positive aspect I can see is that this adds incremental pressure onto the SEC to desist with its regulation by enforcement stance which is subject to sustained criticism from all sides.

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There is a little known rule-change relating to the custody of crypto assets introduced in April 2022:

https://www.sec.gov/oca/staff-accounting-bulletin-121

This arcane accounting change has some potentially serious ramifications. The key quote is this one:

“Accordingly, as long as Entity A is responsible for safeguarding the crypto-assets held for its platform users, including maintaining the cryptographic key information necessary to access the crypto-assets, the staff believes that Entity A should present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform users.”

This rule change relates to the entity that holds the private key giving access to crypto-assets. What it appears to be saying is that the institution that holds the private keys (i.e. the custodian) must record the fair value of those crypto-assets as a liability on its balance sheet.

As Matt Walsh pointed out on Twitter:

“To be clear, this accounting treatment would be in conflict with every other asset that custodians safekeep. For example, State Street has over $40 trilion in customer assets under custody. Imagine them having to put those on their own balance sheet? It makes zero sense.”

…

But then the waters are muddied somewhat:

“… it would be appropriate for Entity A to recognize an asset at the same time that it recognizes the safeguarding liability, measured at initial recognition and each reporting date at the fair value of the crypto-assets held for its platform users.”

So the custodied crypto-assets are both an asset and a liability making the capital allocation as either 100% or 0%. Do you toss a coin to decide?

The SEC is failing in its governance of crypto rules on every single level.

Curious Cryptos’ Commentary – Crypto regulation in the US

The SEC’s obvious failings are not being overlooked.

A new bill has been introduced with the aim “To provide for a system of regulation of digital assets by the Commodity Futures Trading Commission and the Securities and Exchange Commission, and for other purposes”:

https://agriculture.house.gov/uploadedfiles/fit_for_the_21st_century_act_of_2023.pdf

An associated “Myth versus Fact” document makes for some entertainingly light reading if you are at a loose end:

https://agriculture.house.gov/uploadedfiles/market_structure_myth_v_fact.pdf

A key provision is to allow for the registration of crypto intermediaries (centralised exchanges, custodians, etc) with both the SEC and the CFTC, a process that is almost entirely lacking right now. When the regulators – and specifically the SEC – refuse to engage with crypto firms, their existence becomes one of regulatory precariousness.

Even more excitingly, a pathway is laid out for specific cryptos to be categorised as sufficiently decentralised to be deemed commodities, not securities.

In exchange for these two milestones, the requirements for disclosure and reporting are appropriately onerous.

Introduced as a partisan bill, unfortunately I suspect very little progress will be made going forward.