If this is the first you’ve heard of it, or you’re not sure what’s going on, here is a quick recap. The SEC issued SAB121 in March 2022 (pre-FTX by a few months). It specifically addresses entities holding people’s crypto on their behalf. It faced push-back right away. Things got more exciting this May when the House of Representatives voted to repeal SAB121 with a vote of 228 to 182 on May 22. The Senate followed with another vote of 60 to 38 on May 29. These were reasonably bipartisan votes, which is notable since the two sides rarely agree on much. However, on May 31, President Biden vetoed the repeal bill. Then, last week, the House attempted to override the presidential veto, but the vote came back at 228-184, short of the two-thirds majority needed. This is pretty exciting drama for an accounting bulletin.
But this has been an exciting spring for crypto all around. It started with Bitcoin ETFs being announced, then went into a new all-time high, SBF charged, CZ charged, the Bitcoin halving, the Tornado Cash trial, FIT21 passing the US House, and then our SAB121 drama.
What’s the Big Deal with SAB121?
SAB121 requires companies holding crypto for users to keep these assets on their balance sheets. Why was this such a hot issue? I’m not an accountant, so I was trying to figure this out.
If I deposit money into a bank, it goes on their balance sheet:
- The money the bank owes me becomes a liability (debt) on the liability side of the balance sheet.
- The money I have given them becomes an asset in their vault.
The bank isn’t better or worse off because of my deposit; it is entered on both sides of the balance sheet. So, with crypto, if I deposit 10 BTC into Coinbase, PayPal, or another provider, why wouldn’t they record that as a liability (debt) to me and an asset now in their possession?
First of all, it is important to understand this is not a crypto issue, just like FTX wasn’t really a crypto issue in the true sense. Bitcoin, with blockchain technology, and now other cryptocurrencies, are a big deal because it allows people to hold their own assets. The revolutionary aspect of this technology is that intermediaries (banks and custodians) aren’t required. The promise of crypto is ‘Banks can fail and be corrupt, so you need to hold your own money because you can’t trust them to do it for you’. SAB121 only affects those who want to own crypto but don’t want to hold it themselves. It addresses the use of custodians for crypto, which is arguably against the reason crypto was created: to eliminate the need for custodians. SAB121 doesn’t deal with people holding their own crypto, companies holding their own crypto, or buying and selling with crypto. It is specifically intended for organizations holding crypto accounts for users and is designed to protect those users’ deposits by having the holding company consider them a debt to the individual who deposited them.
I’m all about crypto, and I struggle to see this regulation as a bad thing or, as some view it, a massive attack on the industry, especially after FTX and other custodian fallouts.
It’s also important to note that many people like and prefer to interact with crypto through intermediaries. It feels easier and simplifies trading.
So, while crypto was developed for self-custody and wasn’t intended as an investment vehicle, this is how many people interact with and perceive it. Therefore, I would argue that SAB121 isn’t really a crypto issue but a side issue for those using crypto outside its intended purpose. And because this is risky, the SEC is trying to protect them.
To recap, this isn’t specifically crypto regulation and doesn’t affect people’s ability to hold or use their own crypto. It also doesn’t change the balance of a balance sheet because the liability (debt) to the user is balanced by the asset the custodial company holds.
Why the Drama?
Complying with SAB121 is operationally complex. As best I can understand, it requires upgrading accounting systems. Cryptocurrency assets on the balance sheet are more volatile and seen as riskier. However, I don’t understand why this is an issue if the same conditions match the liability/debt. If my 10 BTC drops or goes up, the balance sheet remains balanced—the company still owes me 10 BTC.
This isn’t to minimize it; operational complexity is a real issue and likely significantly constrains companies wishing to be custodians of users’ cryptocurrency. This makes it harder for banks, centralized exchanges, and payment gateways like PayPal to comply with these regulations.
On the other hand, this regulation requires acknowledgment that these companies hold liabilities and debts to customers for deposited cryptocurrency. It is important to understand the risk these companies are taking if there is a hack and cryptocurrency is lost.
While there are real safety concerns, these specific SAB121 requirements may (potentially) have unintended consequences of limiting or slowing down crypto adoption and the development of these companies, especially smaller or start-up ones.
How do Other Jurisdictions Handle This?
MiCA, the EU regulation coming into effect this year, imposes significant requirements on Crypto-Asset Service Providers (CASPs), including those offering custodial services. These regulations are more crypto-informed and widespread but do not specifically require these assets and liabilities to be on the balance sheet like SAB121. Likely, the best situation for the US is to have more informed regulations around crypto custodians, making it easier for companies to enter the crypto service space while still providing significant safeguards for users who wish to have their crypto stored by a service.
Interestingly, this week’s news includes the SEC making some exceptions for this rule, provided companies follow other steps to protect customers’ assets in case of failure or bankruptcy.
Questions to Consider:
- With the number of users hurt by centralized custodians failing, what is a good way of ensuring that these custodians are held liable for the deposited assets?
- Why has this become such a hot topic within the crypto industry when it only addresses centralized players?