On January 23, 2023, the New York Department of Financial Services (DFS) released regulatory guidance to better protect customers in the event of virtual currency bankruptcy. The instructions are not binding, but persuasive.
The guidelines apply to companies that licensed or chartered by DFS to manage virtual currency assets on behalf of their clients. These settlement entities, known as Virtual Currency Entities (VCEs), are expected to have extensive processes similar to traditional financial services firms.
In general, New York’s virtual currency regulation requires VCEs to:
Hold virtual currencies in a way that protects customers’ assets
Keep comprehensive books and records
properly disclose the material terms and conditions related to their products and services, including custody services
Do not make any false, misleading or misleading representations or omissions in their marketing materials.
The new regulatory guidelines on insolvency address the following key points, each of which is explained below:
Segregation and Accounting Separation of Customer Virtual Currency: The VCE Custodian should account for and segregate the Customer Virtual Currency separately from the corporate assets of the VCE Custodian and its affiliates both on-chain and in the internal ledger accounts of the VCE Custodian.
Limited interest of VCE: DFS expects that when a client transfers ownership of an asset to a VCE custodian for the purpose of custody, the VCE custodian will only hold the client’s assets for the limited purpose of providing custody and custody services in takes possession, namely it does not establish a debtor-creditor relationship with the customer.
Sub-custodial Agreements: A VCE Custodian may elect, after due diligence, to arrange for the custody of Customer’s Virtual Currency through a sub-custodial agreement with a third party, provided such agreement is consistent with the Policies and approved by DFS.
Client Disclosure: The custodian is expected to clearly disclose to each client the terms and conditions related to its products, services and activities, including how the VCE custodian segregates the virtual currency in custody, as well as the client’s retained property and accounts for interest in the virtual currency. The VCE Custodian Client Agreement should make clear the intentions of the parties to enter into a custodial relationship rather than a debtor-creditor relationship.