The U.S. Securities and Exchange Commission has proposed new rules governing how registered investment advisers custody client crypto assets, and counsel at Bitwise Asset Management say the draft leaves decentralized finance vaults in regulatory limbo.

The proposal extends the agency's long-standing "qualified custodian" framework, codified in Rule 206(4)-2 under the Investment Advisers Act of 1940, to digital assets held by advisers. The framework has required client funds and securities to be placed with regulated third-party custodians since 1962, a structure that does not map cleanly onto code-based asset management.

What does the proposal cover?

The draft applies the Custody Rule's existing requirements to crypto assets, including segregation, recordkeeping, and surprise examinations. Advisers would still need to rely on qualified custodians, but the rule must define what counts as one in a market where assets routinely move through self-custodial wallets, multi-signature arrangements, and autonomous smart contracts.

How do DeFi vaults work, and why are they in limbo?

DeFi vaults manage user deposits through code deployed on public blockchains, typically Ethereum, Solana, or comparable networks. They execute strategies such as lending, automated market-making, or yield farming without a traditional intermediary holding the underlying tokens. That architecture does not align with the Custody Rule's assumptions about who safeguards client property.

According to counsel at Bitwise, the proposal as drafted does not address how non-custodial smart contract systems fit within the qualified-custodian model. The assessment, reported by TradingView, frames the omission as a central flaw that could chill institutional engagement with DeFi.

What are the operational consequences?

Advisers that route client exposure through DeFi protocols could face three concrete questions:

• Whether a smart contract or its governance token holders constitute a "custodian" under the rule.
• Whether advisers must retain a third-party qualified custodian even when assets sit autonomously on-chain.
• How custody obligations apply to wrappers, structured products, or tokenized funds backed by DeFi yield.

Uncertainty on any of these points could push asset managers toward centralized venues and institutional custodians with established regulatory standing, or away from DeFi exposure until the SEC clarifies its position. Bitwise, which manages spot Bitcoin and Ethereum exchange-traded products alongside separately managed accounts, has direct exposure to both sides of that calculus.

Why has the gap persisted?

The Custody Rule was last substantively updated in 2009, well before the first Bitcoin block. SEC staff has spent the intervening years signaling through enforcement actions and guidance that digital assets fall within the rule's scope, but formal rulemaking has lagged. Industry feedback during the agency's prior roundtables, including the 2018 and 2019 events on custody and the 2023 Custody and Treasury Management panel, repeatedly surfaced the DeFi-mapping problem. The new draft's reported failure to resolve it suggests the agency either intends to address DeFi in separate rulemaking or prefers to let the question develop through case law.

What comes next?

The SEC is expected to open the proposal for public comment following publication in the Federal Register. Asset managers, protocol developers, and custody providers will likely use the comment window to press for explicit language accommodating self-custodial and smart-contract-based arrangements, or for a defined safe harbor covering adviser interaction with DeFi under specified conditions. The shape of any such accommodation will determine whether the rule modernizes custody oversight or freezes institutional DeFi participation for another regulatory cycle.