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According to a person familiar with the idea, U.S. President Joe Biden's administration would persuade Congress to require cryptocurrency exchanges to keep their clients' money separate from their own company finances.

Following Coinbase's (COIN) recent announcement that if the business entered bankruptcy, clients' funds would be frozen, federal officials aim to press U.S. politicians to remedy the situation by urging that a future regulatory framework compel crypto companies to keep consumer assets walled off. This type of custodial arrangement is common for financial organizations such as futures platforms, but cryptocurrency exchanges often mix their assets with clients' holdings in the same pot — a practice the government seeks to stop through law. Funds are frequently mixed in the securities sector, but the investments are also more carefully regulated.

According to the individual, federal authorities will push in the coming weeks to include the amendment in any crypto law approved by Congress, expanding on a claim made last year in the President's Working Group on Financial Markets report on stablecoins: Companies that host cryptocurrency wallets must be closely monitored by the federal government. The administration believes that trading platforms should still allow clients' funds to be pooled, allowing corporations to continue handling deals internally rather than needing to record each transaction on a blockchain.

Coinbase, a publicly traded company and one of the largest exchanges in the industry, admitted last week in a filing to the Securities and Exchange Commission that "in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors." That is the lowest rung of individuals paid back when a firm fails, implying that a mistake by Coinbase might lock up clients' tokens permanently - or divert them away to pay other creditors.

"Don't imagine you truly own your tokens when you put them in a digital wallet," Securities and Exchange Commission (SEC) Chair Gary Gensler warned this week at a conference, highlighting some of the federal government's worries regarding the custody of investors' assets. "If the platform fails, you just have a counterparty relationship with the platform. Queue in the bankruptcy courts."

When a company has a customer's tokens, they are free to utilize them anyway they see fit, according to Gensler. In fact, he claims that the exchanges "frequently trade against you." And, given that consumers lost billions in the devastation caused by Luna's algorithmic stablecoin, terraUSD (UST), his investor-protection campaign may gain traction.

"Congressional Democrats will follow his lead and amplify their requests for tighter monitoring," Cowen Group, Inc. analyst Jaret Seiberg predicted in a research report this week. "The problems with TerraUSD and the collapse in cryptocurrency prices will make it more difficult for Republicans to effectively oppose Gensler's policy agenda."

Coinbase, for its part, informed its worried customers and investors that the upsetting splash of its SEC filing wasn't meant to imply anything about its prospects, despite a more than 80% drop in its share price since last year. Founder and CEO Brian Armstrong stated that the disclosures were just in response to a new SEC rule, and that his firm is not in risk of declaring bankruptcy.

For the time being, the top cryptocurrency platforms – which include names like Binance.US, FTX, and Kraken – do not need to strain themselves to fulfill the administration's drive for a custody requirement. A deeply divided and practically immovable Congress is unlikely to achieve anything this year, especially as politicians prepare for the bloodbath of the November midterm elections. The most optimistic predictions predict that a crypto law would gain steam when the dust settles on the new Congress next year.

However, not everyone believes that enclosing clients' funds is the best solution.

"Rather than concentrating on the absence of client asset segregation at digital asset exchanges, which is also true for assets held in'street name' at DTCC," stated Dave Weisberger, co-founder and CEO of CoinRoutes, Inc. It may grant investors "primary status in bankruptcy proceedings," as well as establish a backup fund to compensate losses similar to the one securities investors enjoy.

Others argue that a rule prohibiting corporations from combining their customers' assets with their own would still be a bare minimum for those advocating for strict investor safeguards.

"A lot more has to be done," said Patrick McCarty, a financial expert and former regulator who teaches cryptocurrency lectures at Georgetown Law. He called segregated accounts a "major step forward," but noted that tight rules and a deeper revamp of the business model are required to revert to the basic goals of crypto, which were to record every transaction on an irreversible public ledger.

"Why would one argue for a bandage, however big, when it appears that extensive surgery is required to safeguard investors?" McCarty explained.

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