US Regulator Proposes Scrutiny of Crypto's Relationship with Hedge Funds

The new rules would force institutional fund managers in the U.S. to transfer their clients' cryptocurrency assets to qualified custodians.

The United States Securities and Exchange Commission (SEC) is planning to propose stricter regulations for hedge funds working with cryptocurrencies under a new draft proposal that would make it challenging for crypto firms to qualify as custodians for money managers.

According to Bloomberg, the new rules would require hedge funds to register with the SEC and disclose more information about their activities in cryptocurrencies. Hedge funds, but also private equity firms, certain venture capital firms, and pension funds would be affected, as they are required to safeguard their clients' assets through qualified custodians. The SEC's proposal to scrutinize crypto firms as qualified custodians is part of the government's efforts to address the potential risks that cryptocurrencies could pose to the overall financial system.

The proposal has not yet been finalized, but if implemented, it would bring significant changes to the way hedge funds operate in the crypto industry. If approved, these organizations will need to move their customers' assets to other custodians and may face audits of their custodial relationships and other consequences. It would also mandate that hedge funds maintain records of their clients' digital wallets and exchanges used, as well as any transactions made.

For the proposed rule to be issued for public comment, most of the five-member SEC would have to approve it. After receiving feedback, the SEC would need to vote once more to finalize the rule for it to take effect.

The move comes in response to several high-profile failures in the crypto industry – including the collapse of FTX and Voyager Digital – and concerns about potential risks associated with cryptocurrencies, such as market volatility and lack of transparency. The regulators have taken a more aggressive approach to the industry in recent times.