Regulators once again offered piecemeal guidance, while focusing on risks and enforcement. Meanwhile, innovation and institutional adoption took off.

By Stephen P. Wink, Todd Beauchamp, Yvette D. Valdez, Eric S. Volkman, Adam Bruce Fovent, and Deric Behar

Last year, Latham & Watkins sounded a hopeful note that 2020 would provide a clearer vision than 2019 for the regulation of digital assets in the US. In the wake of the emergence of COVID-19, priorities changed, along with forecasts and expectations. The second and third quarters of 2020 had regulators of all stripes in triage mode, and any attention they may have directed at cryptoassets was understandably shelved. On the other hand, far from sidelining digital asset growth, the pandemic appears to have spurred further innovation and adoption. Regulators are now continuing to reckon with an asset class that remains without a comprehensive regulatory framework in the US.

In a year-end change of course, the SEC identified the minimum steps that broker-dealers must take when acting as custodians of digital asset securities.

By Stephen P. Wink, Naim Culhaci, Shaun Musuka, and Deric Behar

On December 23, 2020, the US Securities and Exchange Commission (SEC) staff issued a statement (Custody of Digital Asset Securities by Special Purpose Broker-Dealers) (the Statement) outlining its position on how broker-dealers must operate when acting as custodians of digital asset securities[i] in order to avoid enforcement action. The SEC’s Statement, which will be in effect for five years, is intended to encourage innovation while providing both industry participants and the SEC the opportunity to develop best practices with respect to the custody of digital asset securities.

SEC relief streamlines noncustodial settlement of digital asset trades, but broker-dealer custody is still off-limits.

By Stephen P. Wink, Naim Culhaci, and Deric Behar

On September 25, 2020, the US Securities and Exchange Commission (SEC) issued a no-action letter (the Letter) granting more leeway to registered alternative trading systems (ATSs) that settle trades involving digital asset securities. The no-action relief is intended to reduce operational and settlement risks that ATSs face as they seek ways to provide noncustodial digital asset services, including settlement of trades involving virtual currencies, coins, and tokens.

The milestone fund structure portends a reduced role for broker-dealers, who may be sidelined by innovators unwilling to wait for regulators.

By Stephen P. Wink and Deric Behar

On July 6, 2020, asset management firm Arca announced that the US Securities and Exchange Commission (SEC) granted it approval under the Investment Company Act of 1940 to issue shares of a closed-end US Treasury fund in the form of digital securities. The fund will comprise a managed portfolio invested primarily in interest-bearing and low-volatility short-term US government bills, bonds, and notes. Interests in the fund will be purchased directly from the fund and will be issued to approved Ethereum wallets as “ArCoin” ERC-1404 tokens, digital securities that are transferable using blockchain technology. ArCoins are decidedly not cryptocurrencies or stablecoins, but are securities tokens representing equity interests in the fund, with a net asset value that will fluctuate based on the value of the fund’s underlying Treasury assets in the same manner as other mutual fund shares.

In line with its previous guidance, FINRA has granted broker-dealer (but not custodian) status to a digital asset platform.

By Stephen P. Wink, Cameron R. Kates, Shaun Musuka, and Deric Behar

In a follow-up to the July 2019 SEC and FINRA joint staff statement (Joint Statement) clarifying the regulators’ position on the custody of digital asset securities by broker-dealers, on September 27, 2019, FINRA granted broker-dealer status to a digital asset firm. The recipient, Harbor Square Investments (HSI) — a subsidiary of a San Francisco-based FinTech startup eponymously named Harbor — helps issuers of alternative investments and private securities tokenize their offerings and bring the security tokens to market on its blockchain-based platform.