On March 31, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 121 (Bulletin), noting that a company safeguarding or exerting custody over cryptocurrency on behalf of its platform users must clearly report the users’ assets as liabilities on the company’s financial statement, along with the risks consumers face by entrusting the company with their private, cryptographic keys.

Public-Key Cryptography. Public-key cryptography is a type of encryption scheme that uses two nonidentical, corresponding keys to encrypt and decrypt data. One of these keys is public — like an email address — and can be discovered by any user of a public blockchain. For example, in a peer-to-peer transaction, parties exchange public wallet addresses (i.e., public keys) to facilitate transfer and receipt of crypto-assets. When Party A sends a crypto asset to Party B’s public wallet address, Party A is sending Party B encrypted data that lives on the blockchain. To decrypt this data, Party B must have access to the private key that corresponds to the public key he provided to Party A. Stated differently, in public-key cryptography, only the private key owner can decrypt encrypted data sent to his or her public key, which affords this person complete control over the underlying crypto-assets.

Practical Considerations. As the Bulletin makes clear, users of entities who hold their crypto-assets in digital wallets provided on the entities’ platforms are not the true owners of those crypto-assets as the entities maintain the private, cryptographic keys necessary for platform users to access their crypto-assets. To mitigate risk of exposure to loss of platform users’ private, cryptographic keys (which would result in total loss of the underlying crypto-assets), the SEC suggests these entities will be required to engage in certain practices:

  • Report the obligation associated with these custody arrangements as liabilities on their balance sheets (safeguarding liability);
  • Measure safeguarding liabilities and crypto assets at fair market value at the time of acquisition; and
  • Make disclosures concerning the risks associated with entrusting one’s cryptographic key information to a third party, such as theft or loss.

The Bulletin requires entities that file with the SEC to comply with this updated guidance by June 15, 2022.

Our Take. Although the Bulletin does not provide a comprehensive regulatory framework, it suggests the SEC perceives public-key cryptography as both a unique and potentially hazardous phenomenon.

Print:
Email this postTweet this postLike this postShare this post on LinkedIn
Photo of Keith J. Barnett Keith J. Barnett

Keith’s experience representing clients in the financial services industry as a litigation, compliance, regulatory, investigations (internal and regulatory), and enforcement attorney spans 20 years. Keith represents clients against government regulators (CFPB, FTC, SEC, CFTC), industry regulators (FINRA), and private litigants in federal courts…

Keith’s experience representing clients in the financial services industry as a litigation, compliance, regulatory, investigations (internal and regulatory), and enforcement attorney spans 20 years. Keith represents clients against government regulators (CFPB, FTC, SEC, CFTC), industry regulators (FINRA), and private litigants in federal courts, state courts, and before arbitration and administrative law panels in the financial services industry.

Photo of Jay Dubow Jay Dubow

Jay co-leads the firm’s Securities Investigations + Enforcement Practice Group. He focuses his practice on complex business litigation, with a special emphasis on defending against shareholder derivative and securities class action litigation. He also represents clients involved in investigations by the U.S. Securities…

Jay co-leads the firm’s Securities Investigations + Enforcement Practice Group. He focuses his practice on complex business litigation, with a special emphasis on defending against shareholder derivative and securities class action litigation. He also represents clients involved in investigations by the U.S. Securities and Exchange Commission (SEC), the Pennsylvania Department of Banking and Securities, and various self-regulatory organizations, including the Financial Industry Regulatory Authority, Inc. (FINRA). He also conducts internal investigations on behalf of clients. Such investigations have included allegations involving the Foreign Corrupt Practices Act (FCPA), whistle blower claims, financial fraud, and civil and criminal violations of various federal and state laws.

Photo of Kalama Lui-Kwan Kalama Lui-Kwan

Kalama represents parties in complex commercial disputes arising out of M&A deals. He also has a national litigation practice representing consumer-facing companies in class actions and regulatory investigations.

Photo of Ethan G. Ostroff Ethan G. Ostroff

Ethan Ostroff’s practice focuses on financial services litigation and consumer law compliance counseling. Ethan is part of the firm’s national practice representing consumer-facing companies of all types in defense of individual and class action claims and counseling them on compliance with federal and

Ethan Ostroff’s practice focuses on financial services litigation and consumer law compliance counseling. Ethan is part of the firm’s national practice representing consumer-facing companies of all types in defense of individual and class action claims and counseling them on compliance with federal and state laws.

Photo of Ghillaine Reid Ghillaine Reid

Ghillaine co-leads the Securities Investigations + Enforcement Practice Group at Troutman Pepper. She focuses her practice on government and securities regulatory investigations, financial services litigation, commercial litigation, and corporate compliance. Drawing on her experience in government service and private practice, Ghillaine regularly represents…

Ghillaine co-leads the Securities Investigations + Enforcement Practice Group at Troutman Pepper. She focuses her practice on government and securities regulatory investigations, financial services litigation, commercial litigation, and corporate compliance. Drawing on her experience in government service and private practice, Ghillaine regularly represents corporations and individuals in investigations conducted by the Securities & Exchange Commission, the Department of Justice, the Financial Industry Regulatory Authority, and other government and regulatory agencies. Ghillaine has successfully defended several high profile SEC investigations and enforcement proceedings involving a wide range of significant issues, including insider trading, accounting fraud, market manipulation, and broker-dealer sales practice violations. Prior to entering private practice, Ghillaine was a Branch Chief and Staff Attorney in the New York Regional Office of the Securities & Exchange Commission’s Division of Enforcement, where she investigated and litigated a wide range of securities enforcement matters.

Photo of Carlin McCrory Carlin McCrory

Carlin is a regulatory, compliance, and payments attorney with experience representing financial institutions, fintechs, lenders, debt collectors, payment processors, neobanks, virtual currency companies, and mortgage servicers.

Photo of Addison Morgan Addison Morgan

Addison is an associate in the firm’s nationally recognized Consumer Financial Services Practice Group. He has represented several of the nation’s preeminent financial institutions in litigation arising under the Fair Credit Reporting Act (FCRA), the Telephone Consumer Protection Act (TCPA), the Fair Debt…

Addison is an associate in the firm’s nationally recognized Consumer Financial Services Practice Group. He has represented several of the nation’s preeminent financial institutions in litigation arising under the Fair Credit Reporting Act (FCRA), the Telephone Consumer Protection Act (TCPA), the Fair Debt Collection Practices Act (FDCPA), the FTC Holder Rule, and other consumer protection state analogs.

Photo of Elizabeth Waldbeser Elizabeth Waldbeser

Elizabeth is an associate in the firm’s Business Litigation Practice Group. She represents clients in a diverse array of litigation matters in federal and state courts at the trial and appellate levels.