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Why Nasdaq Withdrawing from Custody Is Bad News for Crypto

Nasdaq, a well-known and technologically advanced U.S. stock exchange, declared yesterday that it is abandoning its intentions to introduce a bitcoin custody service. The second quarter of this year saw the planned introduction of the new business line, which would have been subject to New York’s special purpose trust regulations.
The announcement is a serious setback given the crypto industry’s recent signs of vigor. A sudden proposal for a spot bitcoin exchange-traded fund (ETF) from BlackRock, the largest asset manager in the world, this month reignited hope for an asset class that had been battered by regulations and bad news for at least the previous 16 months.

BlackRock indicated that there is still significant institutional interest in bitcoin and cryptocurrencies despite the current, seemingly concerted crackdown on cryptocurrencies by U.S. authorities (often referred to as “Choke Point 2.0”). Following a flurry of other spot bitcoin ETF registrations, the U.S. Securities and Exchange Commission (SEC) missed its window to block the trading of a different but equally intriguing sort of bitcoin ETF, giving the white-collar side of cryptocurrency a victory. The markets recovered.

In addition to all of this, a significant victory for Ripple last week in a protracted legal battle with the SEC obscured the Silicon Valley blockchain pioneer’s costly technical loss after a district judge determined that over $700 million of Ripple’s direct sales of XRP to hedge funds constituted illegal securities offerings. As a number of U.S. and foreign crypto exchanges revealed plans to resume XRP trading, reversing a wave of delistings from 2020, XRP short sellers were liquidated.

The decision by Nasdaq to leave the cryptocurrency custody market before it had fully entered is probably insufficient to halt the rising optimism in the market. It is still a blow, though, and one that suggests that if the current regulatory system is maintained, much of the business may be headed in the wrong direction.
Adena Friedman, the CEO of Nasdaq, stated during a quarterly earnings call that the company withdrew due to “the shifting business and regulatory environment in the United States,” a claim that has been made frequently in relation to cryptocurrency over the past year. The company first revealed its custody plans in September along with the creation of a new division called Nasdaq Digital Assets, a move the company is still committed to making. According to Friedman, the company still has ambitions to “build and deliver” cryptocurrency technologies, such as various custody options, and list BlackRock’s spot bitcoin ETF if that application is granted.

Still unknown is the precise reason Nasdaq is pulling out, including if there is a direct cause or whether this is simply an instance of a business reading the signs. (CoinDesk has inquired for additional comment.) It is unknown whether the corporation’s proposed limited trust-purpose trust company received official approval despite the fact that it is said to have been in discussions with the New York State Department of Financial Services (NYDFS) for months.
Notably, the SEC voted in February to broaden its current regulations to cover all trading and lending companies by mandating that they store customer assets with “qualified custodians,” which are defined as chartered banks or trust companies, SEC-registered broker-dealers, or Commodity Futures Trading Commission (CFTC) derivatives merchants. The proposition is referred to by Crypto as the “custody rule.”

The regulation, which requires approval before it takes effect, affects other asset classes besides cryptocurrencies, although it appears to be intended to restrict full-stack cryptocurrency firms like Coinbase that provide both trading and custody services. Famously (or infamously), Coinbase is not registered with the SEC (apart from having the same body approve its IPO), and it disagrees with the proposed criteria to be “qualified” as a custodian.

Legalized gambling on securities is typically divided into three different services in traditional finance: trading is handled by exchanges, the assets being exchanged are stored by custodians, and trade settlement is overseen by clearinghouses (the blockchain handles this function automatically in the case of crypto assets). It’s important to note that several established financial players, including JPMorgan and the Small Business Association, strongly opposed the SEC’s “sweeping changes,” despite the fact that they may stand to gain if crypto companies were forced to look outside the crypto field for licensed custodians.

A company like Nasdaq might seem capable of navigating the bureaucracy, which is why their decision to withdraw from cryptocurrency custody is so instructive. Who else can do it if they can’t? Although the SEC’s stronger custody regulations have not yet taken effect, it is more and more likely that trading and custody services will be regulated separately in the future. Marc Hochstein from CoinDesk concurs with the notion, and several bipartisan proposals currently before the US Congress make the same suggestion.

Any company that does not provide non-custodial crypto services will undoubtedly be impacted by the increased scrutiny that will, in one way or another, be given to crypto custody. Also, good. If these modifications had been in place (and assuming for the sake of argument that the foreign exchange was governed by U.S. law), Sam Bankman-Fried would not have allegedly been able to access FTX client accounts. Such regulations would probably be most advantageous to established financial institutions and BitGo, the market leader in crypto custody, in the short to medium term. But even that might be better than the current state of affairs, given how many crypto-native custodial firms continue to let the ball drop.

However, it is not encouraging that Nasdaq cannot entirely understand the legislation or what is coming up (or was even alarmed by the XRP ruling). The industry’s foundational element is crypto custody. There must be practical answers for everyone else, even if you are able to hold your own keys.

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