• The New York Department of Financial Services (NYDFS) has issued guidance to custodial structures to protect customers‘ money if a crypto firm goes bankrupt.
• The guidance emphasizes the need for businesses to not commingle customer funds and for customer funds to be segregated with separate accounting.
• The guidance provides a summary of four policies and standards that virtual currency entities should adhere to, including segregation of and separate accounting for customer virtual currency, the 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) has recently released guidance on custodial structures to help protect customers‘ money if a crypto firm goes bankrupt. This guidance was issued following the collapse of FTX and the allegations that had been directed at its co-founder, Sam Bankman-Fried, and top deputies.

The guidance was issued by Adrienne Harris, the superintendent of the NYDFS, and she stressed the importance of businesses not commingling customer funds, and that customer funds should instead be segregated with separate accounting. Harris further provided a summary of four policies and standards that virtual currency entities (VCEs) should adhere to.

The first policy is the requirement for VCEs to segregate and separately account for customer virtual currency. This means that customer assets must be kept separate from the corporate assets of the VCE custodian and any affiliated entities, both onchain and on the VCE custodian’s internal ledger accounts.

The second policy is that the VCE custodian should have a limited interest in and use of customer virtual currency. This means that the VCE custodian should not use customer virtual currency for any purpose other than safeguarding it on behalf of the customer.

The third policy is that sub-custody arrangements should be considered. This means that VCEs should consider engaging in sub-custody arrangements with third-party custodians. This will help protect customers in the event of a bankruptcy or other insolvency event.

The fourth policy is that customers must be adequately disclosed to. This means that customers must be provided with information about the risks associated with custody of virtual currency and the policies and procedures that the VCE custodian has in place to protect customer assets.

In conclusion, the NYDFS guidance provides a clear framework for VCEs to follow in order to protect customer assets and preserve trust. The guidance emphasizes the need for customer funds to be segregated with separate accounting, and for VCE custodians to have limited interest in and use of customer virtual currency. Additionally, the guidance encourages VCEs to consider engaging in sub-custody arrangements with third-party custodians, and to provide customers with adequate disclosure.