Cryptocurrency and the Custody Rule: Legal Pitfalls in Managing Digital Assets

Description

Custody generally refers to the possession or control of an asset. Digital assets are reflected on distributed ledgers in the form of binary digits. They may represent cryptocurrencies like Bitcoin, the ownership of physical or other assets, or the right to deploy smart contracts on a blockchain platform. Counsel must be able to advise investors and their advisers on how to establish and maintain custody of these virtual assets.

A private key is necessary to claim and spend all digital assets associated with a related public key or address on a blockchain. Any person who accesses the private key can spend those assets and, given the immutability of the distributed ledger system, those assets almost certainly will not be recoverable by the owner. Control of the relevant private key is a paramount concern, and safeguarding the private key through secure custodial arrangements is the primary goal under current custody methods.

Rule 206(4)-2 (the Custody Rule) under the Investment Advisers Act establishes specific safekeeping requirements applicable to funds or securities held on behalf of clients by registered investment advisers. Digital assets present storage, control and audit issues not contemplated under existing custody rules. Unlike typical investments in securities and debt instruments, there may not be any registrar records, trusted intermediaries, counterparties, administrative agents, or other traditional sources of ownership verification or evidence of ownership.

Listen as our authoritative panel discusses the operational complexity of custodial arrangements relating to digital assets. The panel will also discuss the security issues presented by blockchain and the unanswered questions relating to third-party custody of digital assets under the Custody Rule and other applicable federal laws.