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Understanding SAB 121 and Its Impact on Crypto Custody

Julie McKenna

Regulating crypto-assets is one of the most contentious issues in the industry. The lack of clear regulations has been a major barrier to widespread adoption, with many arguing that the U.S. is lagging behind other countries in crypto innovation. A notable development in this regulatory landscape is the SEC's issuance of Staff Accounting Bulletin Number 121 (SAB 121).


In April of 2022, the SEC issued SAB 121 to guide entities on accounting for and disclosing crypto-assets they hold for customers. Under this bulletin, entities must recognize a liability on their balance sheets for the fair value of the crypto-assets and provide detailed disclosures about these assets and the associated risks (SEC).


What Does This Mean?

When a bank includes assets on its balance sheet, it has to follow certain rules, one of which is maintaining a cash reserve. This is a safety measure to ensure that the bank can cover any potential losses and meet withdrawal requests.


Custodian banks, such as BNY Mellon, Northern Trust, and State Street, usually don't put the assets they hold for clients on their balance sheets. This is because these assets belong to the clients, not the bank, and the bank is just holding them for safekeeping. Since these assets are not on the balance sheet, the bank doesn't need to keep extra cash on hand.

SAB 121 changes this by requiring banks to put crypto-assets they hold for clients on their balance sheets. This means that now these crypto-assets are considered part of the bank's own assets. As a result, the bank must keep extra cash (5% of the value of these crypto-assets) to meet the safety requirement.


This extra cash requirement makes it very expensive for banks to hold crypto-assets. Even if they charge clients a fee for holding their crypto-assets, the cost of maintaining the required cash reserve would be higher than the fees they could earn. This is why putting crypto-assets on the balance sheet under SAB 121 makes it unprofitable for banks to offer crypto custody services. As a result, some of the most trusted US financial institutions are unable to offer digital asset custody services (Onramp Invest).


What Has Happened Since?

May 16, 2024

The Senate voted 60 to 38 on a resolution to overturn the SEC’s SAB 121, which establishes certain accounting standards for firms that custody crypto. This was a significant move, showing a strong opposition to the financial burdens imposed by SAB 121 on banks and custodians (The Block).


May 31, 2024

President Biden vetoed the bill to overturn SAB 121, stating that the standard is necessary for crypto innovation (The Block).


Now

The U.S. House is set to vote on a resolution to overturn President Biden’s veto on Wednesday, July 10. This vote will require a two-thirds majority in both houses, meaning about 60 more votes are needed to join the initial 228 that supported the vetoed bill (Crypto News).


The Future of Crypto Custody

The outcome of the upcoming vote will have significant implications for the future of crypto custody services in the U.S. If the House manages to overturn the veto, it could ease the financial burdens on banks, making it more feasible for them to offer crypto custody services. On the other hand, if the veto is upheld, banks will continue to face high costs associated with holding crypto-assets.




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