The World Federation of Exchanges (WFE), the global industry association representing exchanges and central clearing counterparties, has issued recommendations outlining best practices for crypto-asset custody providers.
These guidelines draw from the experiences of traditional financial markets to help shape and guide the evolving digital asset sector.
The ruling against FTX and Alameda in the US earlier this month exemplifies the broader shift in expectations for the crypto industry to be held to higher standards closer to that of well-functioning finance, ensuring stronger protections for investors.
The WFE highlights inadequate custody controls among crypto platforms as a critical issue that must be addressed, as it poses significant risks to market integrity and investor protection.
Without robust custody controls, there is an increased risk of financial loss, fraud, and mismanagement, which can erode investor confidence and undermine the overall integrity of the markets.
The report addresses the urgent need for regulation and best practices in the wake of high-profile failures within the crypto industry and this can make the difference in attracting investment from institutions yet to allocate to crypto.
According to the report, the WFE advises crypto custody providers to implement several key measures.
These include segregating client assets to ensure their protection in the event of a company’s bankruptcy, maintaining client assets as bankruptcy-remote—meaning they are kept separate from the assets of other legal or natural persons—and addressing cyber risks through robust technology architecture and mature cybersecurity programs.
Additionally, the WFE recommends that crypto custody providers offer services beyond mere asset holding or administration, effectively manage and address conflicts of interest, and ensure comprehensive operational resilience across their support models.
They should also provide clear and understandable risk disclosures, particularly for retail customers, maintain adequate insurance or surety bonds with transparent disclosure of these policies, and seek independent audits from reputable and credible auditors to assess financial statements, processes, and controls.
Chief Executive Officer, at the WFE, Nandini Sukumar said, “The FTX collapse and longstanding worries about insufficient custody controls in the crypto industry highlight risks to both market integrity and investor protection.
“Cypto custody providers should learn from more traditional markets that have a track record of functioning well and can start by following the recommendations we have set out today.”
Head of Regulatory Affairs at the WFE, Richard Metcalfe said while these technological innovations and the associated concerns about managing generative AI are significant.
He said, “It is important to remember that, as trusted third parties providing secure and regulated platforms for trading securities, our members are already carefully scrutinising tools and establishing controls to govern AI use.
“The US Treasury should therefore take care to design an AI regulatory framework which is principles based, to maintain flexibility and encourage innovation.
“We also need to have an incremental approach to AI regulation, allowing for gradual adjustments and learning, ensuring that regulations do not hinder technological progress.”