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New York regulator warns crypto firms against commingling corporate and user funds

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(Kitco News) - The New York Department of Financial Services (NYDFS) has issued a new set of guidelines to crypto firms licensed in the state on how they should handle customer assets in order to prevent losses, emphasizing “the paramount importance of equitable and beneficial interest always remaining with the customer.”

NYDFS superintendent Adrienne Harris issued the guidance on Jan. 23, saying that firms that operate under the state’s BitLicense should segregate corporate funds from users’ virtual currency holdings both on-chain and in the “internal ledger accounts” of the company’s custodian.

“To custody customer virtual currency properly and maintain appropriate books and records, a VCE [virtual currency entity] Custodian is expected to separately account for and segregate customer virtual currency from the corporate assets of the VCE Custodian and its affiliated entities, both on-chain and on the VCE Custodian’s internal ledger accounts,” the letter from Harris said.

According to the NYDFS, custodians are only to take possession of a client’s cryptoassets “for the limited purpose of carrying out custody and safekeeping services, and that it will not thereby establish a debtor-creditor relationship with the customer.”

Virtual currencies held by a custodian are to be treated as solely belonging to the customers and custodians are prohibited from employing customer virtual currencies for their own use.

“Under no circumstances should a VCE Custodian use customer virtual currency to secure or guarantee an obligation of, or extend credit to, the VCE Custodian or any other person,” the letter said.

“Further, VCE Custodians are expected to act upon the instructions of their customers or authorized representatives and not acquire general discretion over custodied assets beyond those terms clearly expressed in the VCE Custodian’s customer agreement.”

Custodians are also required to clearly disclose to each customer the terms and conditions for its products, services, and activities. As part of their disclosures to customers, custodians are required to clearly outline how it segregates and accounts for customer virtual currency and how it may use custodied virtual currency while in its possession.

New York regulator says banks need pre-approval to engage in new crypto activities

If a custodian utilizes a third-party, sub-custody arrangement, the customer agreement should clearly disclose the terms of that arrangement and the material risks. All VCE Custodians are required to make their standard disclosures and customer agreements easily accessible to customers on its website, in a manner consistent with New York laws and regulations.

The NYSDF said that the ultimate goal of the new guidance is to safeguard customer assets.

In December, the NYSDF issued guidance to banks in the state that they are expected to seek pre-approval from the Department before engaging in new or significantly different virtual currency-related activities. The Department has also proposed that all BitLicense holders be required to pay for the costs associated with their supervision and examination.

This development from the New York regulator follows several high-profile bankruptcy filings in 2022 – including FTX, BlockFi, Genesis and Voyager Digital – which are likely to result in a significant loss of user funds.

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