The New York Department of Financial Services has issued sweeping new guidance aimed at preventing cryptocurrency custodians from commingling customer funds with their own assets, delivering a clear regulatory response to the spectacular collapses that shook the digital asset industry throughout 2022.
TL;DR
- NYDFS published guidance on January 23, 2023, requiring virtual currency custodians to segregate customer assets from proprietary holdings
- Both equitable and beneficial interests in custodied crypto must remain with the customer, not the custodian or exchange
- Custodians are explicitly prohibited from lending, selling, or pledging customer assets without explicit client direction
- The guidance builds on existing Rule 200.9 requirements but adds new clarity around segregation standards
- Sub-custodian arrangements are permitted but subject to NYDFS approval and due diligence requirements
Post-FTX Regulatory Reckoning
The guidance, published as an Industry Letter on January 23, arrives in the wake of multiple high-profile cryptocurrency bankruptcies, most notably the collapse of FTX in November 2022 and the Genesis bankruptcy filing just days before the letter was issued. The timing signals that New York regulators are determined to close loopholes that allowed custodial platforms to treat customer funds as their own.
Under the new framework, Virtual Currency Entities — defined as any entity conducting virtual currency business involving at least one New York resident — must maintain clear separation between customer holdings and corporate assets. The guidance specifies three acceptable structures for segregation: individual customer-by-customer wallets, internal ledger accounts, or omnibus accounts where multiple customers’ holdings are pooled but still tracked separately.
What the Rules Actually Require
The NYDFS guidance does not create entirely new regulations. Instead, it clarifies and reinforces existing provisions under Title 23, Chapter 1, Part 200, Rule 200.9, which already mandated that custodial entities maintain adequate bonds or trust accounts, hold virtual currency of the same type and quantity owed to customers, and refrain from lending or selling customer assets absent explicit direction.
However, the new guidance adds significant detail about what proper segregation looks like in practice. Custodial VCEs must implement detailed policies and procedures regarding the separation of customer and proprietary assets. The guidance raises a notable question about whether custodians can contribute their own excess cryptocurrency into commingled customer accounts to bolster protections — a gray area that the NYDFS appears to address with caution.
Restrictions on Asset Usage
Perhaps the most consequential element of the guidance is its explicit limitation on how custodians can interact with customer assets. Virtual currency held in custody may only be used for the limited purpose of safekeeping and custody, deliberately avoiding the creation of a debtor-creditor relationship between the platform and its users. Customers’ cryptocurrency cannot be sold, lent, or pledged as collateral for loans to the custodial entity or any third party unless the customer specifically directs such actions.
This provision takes direct aim at the practices that contributed to the downfall of several major cryptocurrency platforms in 2022, where customer funds were allegedly used to finance proprietary trading, venture investments, and loans to affiliated entities without customer knowledge or consent.
Disclosure and Sub-Custody Requirements
The guidance also tightens disclosure requirements under Rule 200.19, which already mandated extensive disclosure of material risks, general terms and conditions, and transactional details. The new clarification requires that disclosures make it unmistakably clear that the parties intend to enter into a custodial relationship — not a lending arrangement or any other type of financial relationship that could put customer assets at risk.
For custodians utilizing sub-custodians, the NYDFS requires prior regulatory approval and comprehensive due diligence on specified factors. This requirement addresses a common criticism of the cryptocurrency custody ecosystem, where opaque sub-custody arrangements have sometimes left customers uncertain about who actually controls their assets.
Why This Matters
The NYDFS guidance represents one of the most detailed regulatory responses to the 2022 crypto industry crisis, and its implications extend well beyond New York. As home to the BitLicense regime — widely considered the most stringent cryptocurrency regulatory framework in the United States — New York’s approach often sets the tone for other states and federal regulators.
With Bitcoin trading at approximately $22,934 and Ethereum at $1,628 on the day the guidance was published, the cryptocurrency market was showing signs of recovery from its 2022 lows. But regulators clearly intend to ensure that the next phase of market growth occurs within a framework that prioritizes customer asset protection over platform flexibility. For the broader blockchain industry, the message is unambiguous: if you hold customer funds, those funds belong to customers — and New York regulators plan to enforce that principle with increasing rigor.
Disclaimer: This article is for informational purposes only and does not constitute financial or legal advice. Readers should consult qualified professionals for guidance on regulatory compliance and cryptocurrency investments.