SEC’s Quiet FAQ Shift Lets Big Banks ‘Control’ Crypto Keys — Why investors should be on alert

What changed and who it touches

The Securities and Exchange Commission quietly updated staff FAQs that affect how broker-dealers can treat cryptocurrency private keys. The change lets regulated banks and broker-dealers show on paper that they “control” private keys without automatically triggering the strict custody and capital rules most people assumed would apply. That matters immediately for big houses such as Morgan Stanley (MS) and Goldman Sachs (GS), which have been building out crypto services, and for the managers that rely on banks to provide custody and market-making for Bitcoin and Ethereum exchange-traded funds.

Exactly what the new guidance says about custody, control, and capital requirements

The FAQs do two things in plain language. First, they offer staff views about when a broker-dealer is deemed to have custody or “possession and control” of crypto assets for regulatory purposes. Second, they explain how that determination affects capital treatment — meaning how much capital a broker-dealer must hold against positions and client assets.

Under the updated text, custody is not automatic simply because a broker-dealer can move an address’s private key. The SEC staff sketches scenarios where a broker-dealer operates wallets, signs transactions, or holds keys on behalf of a client, yet may not be treated as having the full regulatory custody that triggers certain capital charges. The guidance leans on operational controls, contractual terms, and segregated accounting to draw lines between mere access and regulatory custody.

Importantly, the staff guidance is situational. It highlights examples where contractual protections, client consent, audit trails and internal controls could let a broker-dealer claim it is a service provider rather than a custodian. The net effect: firms may avoid some capital and custody obligations if they meet the described guardrails — even while they hold the keys in practice.

What this means for Bitcoin and Ethereum ETFs, market makers and ETF flows

The market impact is immediate and complicated. Listed spot ETFs for Bitcoin and Ethereum rely on custodians and broker-dealer counterparties to move supply into and out of funds. By easing the regulatory line between access and custody, the FAQs lower a paperwork and capital barrier for banks that want to act as custodians or prime brokers for these funds.

That could increase the number of large broker-dealers willing to provide custody and market-making for crypto ETFs. More banks stepping in usually helps liquidity, narrows spreads and supports higher ETF capacity — all positives for the listed funds and for investors seeking reliable on-ramps.

But the change also shifts risk onto fund investors and counterparties. If a bank treats key control as a service rather than formal custody, the fund’s exposure to that bank increases. In times of stress, regulators and courts will have to decide whether the protections the bank promised hold up — and that uncertainty can mean sudden redemptions, wider spreads and stop-start flows into ETFs when confidence falters.

How banks can legally hold or ‘control’ private keys — the mechanics behind custody changes

Operationally there are a few common models. One, a broker-dealer runs hot and cold wallets under its systems and signs transactions on clients’ behalf. Two, a bank uses a separate custodian entity or sub-custodian with independent controls and insurance. Three, a hybrid model where the bank keeps the master key but separates signing authority across units or uses multi-party computation (MPC) so no single server ever holds a complete key.

The new SEC language places weight on the legal and contractual split: who is authorized to direct transfers, who appears on audit trails, who reports holdings to clients, and who holds segregated assets on the books. If a bank can show robust operational segregation, client agreements that assign responsibility, and accounting that keeps client assets off the broker-dealer’s balance sheet, the staff suggests it may not be treated as a custodian in the traditional sense.

That creates a practical picture where control exists in code and operations, while legal custody is engineered to look different — and that difference is what the SEC appears willing to recognize in some cases.

Investor risk map: counterparty, custody and capital shortfalls you need to understand

This is where the cautionary tone matters. The updated FAQ reduces a regulatory friction, but it also widens a gap between operational reality and legal protection. Key risks investors should track:

• Counterparty exposure: Funds and clients may be more dependent on a bank’s promise than on enforceable asset segregation. That promise can be tested in a bankruptcy or run scenario.
• Insolvency risk: If a broker-dealer becomes insolvent, courts will parse contracts and operations. If assets aren’t clearly segregated, creditors could claim access, or assets could be delayed in resolution.
• Insurance gaps: Many policies exclude losses from fraud, certain operational failures, or insolvency — and some insurers are already scaling back crypto coverage. The FAQs don’t change that reality.
• Audit and disclosure weaknesses: The examples in the FAQ rely on strong audits and disclosures. But audits can lag, and disclosure language may be opaque. Investors in ETFs or funds that lean on these models could be reading weaker protection than they expect.
• Capital and market stress: If more broker-dealers treat assets this way, overall industry capital cushions for crypto exposures could be thinner. In a sharp market move, that amplifies liquidity strains — spreads blow out, market makers pull back, and ETF arbitrage frays.

What to watch next — disclosures, enforcement signals and short-term investor actions

Investors and funds should watch three things closely. First, public filings and prospectuses for ETFs and custody agreements: managers must disclose who holds keys, the legal form of custody, and insurance limits. Second, any SEC enforcement comments or follow-ups — the FAQs lower one hurdle, but enforcement and staff letters will reveal how tightly the Commission expects those guardrails to be enforced. Third, balance-sheet reporting from the banks stepping into custody: watch for sudden changes in capital allocations, new footnotes or off-balance-sheet arrangements.

For now, the change can make ETFs and trading easier to run. But it also increases reliance on legal engineering and contractual promises rather than simple, iron-clad segregation. That trade-off benefits speed and scale — and raises the chance of headline shocks when markets get stressed. Investors who care about custody safety should demand clearer disclosures and treat bank custody promises as counterparty exposure, not risk-free protection.

Sources

• cryptoslate.com