SAB 121: The SEC’s Rescinded Crypto Custody Rule—What It Was, Why It Mattered, and What Comes Next

R Tamara de Silva

On January 23, 2025, the Securities and Exchange Commission (SEC) rescinded its guidance requiring crypto assets held on behalf of customers to be listed as both an asset and a liability on a custodian’s balance sheet. Since it took effect in March 2022, Staff Accounting Bulletin (SAB) 121 has largely prevented regulated banks and financial services firms from offering crypto custody services. As a result, it also limited broader crypto-asset offerings these institutions could make available to clients. Many industry insiders breathed a sigh of relief.

1. A Brief History of SAB 121

The rule in question wasn’t a formal regulation. It was Staff Accounting Bulletin No. 121 (SAB 121), issued by the SEC in March 2022. This bulletin told public companies (including financial institutions) that if they safeguarded crypto on behalf of customers, they had to:

1. Record the crypto on the bank’s own balance sheet as an asset.
2. Record an identical amount as a liability (because the crypto technically belongs to the customer).

Traditionally, if a bank holds gold in a vault for you, or if a brokerage firm holds stocks on your behalf, those assets do not appear on the bank’s balance sheet. They are considered “off-balance sheet” because the bank doesn’t own them; it’s merely providing a custodial service. SAB 121 departed from that approach, citing unique legal and technological risks—like cybersecurity threats and evolving bankruptcy rules around digital assets—as the reasons to highlight these holdings more prominently on financial statements.

2. What Made SAB 121 Controversial

From its start, the policy drew criticism from banks and crypto custodians. Many pointed out that it would artificially inflate the size of a custodian’s balance sheet without reflecting a true economic risk. Public disclosures are important, but placing customer Bitcoin (and other digital assets) on the custodian’s books could have led to stricter capital requirements, regulatory burdens, and confusion for investors trying to interpret a firm’s risk profile.

Critics also argued it would deter well-regulated banking institutions from offering crypto custody, potentially pushing crypto business into less supervised corners of the market. Those concerns became even more pronounced when major crypto exchanges began failing or shuttering internationally, underscoring the desire for more—rather than fewer—regulated institutions in the digital asset space.

3. The Letter to Chair Gensler: Banking Associations Speak Out

Well before the rule was rescinded, four major financial industry associations—the Bank Policy Institute (BPI), the American Bankers Association (ABA), the Financial Services Forum (FSF), and the Securities Industry and Financial Markets Association (SIFMA)—co-signed a detailed letter to SEC Chair Gary Gensler. They urged him to consider targeted modifications to SAB 121 and laid out the following points:

• Prudential Implications: By forcing on-balance sheet treatment, SAB 121 subjected banks to elevated capital requirements for assets that belonged to their customers. In their view, this would discourage “highly regulated banking organizations” from offering crypto custody “at scale,” increasing risk for investors who might end up turning to less-regulated entities.
• Overly Broad Definition of ‘Crypto-Asset’: The bulletin grouped any asset recorded on a blockchain under the crypto-asset umbrella. That meant even projects where banks explored using distributed ledger technology (DLT) for traditional assets (like bonds) could fall within the rule’s scope. In the associations’ view, that stifled innovation and conflated vastly different risk profiles.
• Concentration Risk: With big banks effectively sidelined, custodial services for new products (e.g., Spot Bitcoin Exchange-Traded Products) could be concentrated in just a handful of nonbank entities. The letter warned that such concentration might pose systemic risks, precisely what regulators typically try to avoid.
• Proposed Fix: Narrow the definition of “crypto-assets,” exempt well-regulated banking organizations from on-balance sheet treatment, but maintain strong disclosure requirements to keep investors fully informed. The associations argued this approach would preserve transparency while removing a major roadblock to responsible innovation.

4. How This Differs from Holding Gold or Stocks

In most traditional custody scenarios, such as storing gold bars or safeguarding client-owned stocks, these assets never show up on the custodian’s balance sheet because the custodian isn’t the owner.

SAB 121 reversed this approach—but only for crypto. The SEC singled out crypto because of its perceived risks, rather than treating it like traditional custodial assets such as gold, stocks or bonds. The rationale was that customer-held Bitcoin (or other tokens) might create unique contingent liabilities if they were hacked, lost, or tied up in legal disputes. Banks, however, countered that they already follow strict operational and cybersecurity protocols, and that the heightened risk for crypto may not be as universal as the SEC claimed, especially if the custodian is fully compliant with existing banking laws.

5. Potential Consequences of Repealing SAB 121

The repeal removes barriers for mainstream financial institutions interested in offering crypto custody and exchange services. This could lead to widespread adoption and integration of Bitcoin within the banking sector, which may spur tremendous growth in crypto markets.

6. What Could Go Wrong

Without careful regulation, large-scale custodial failures could bring about significant economic fallout.

SAB 121’s short-lived reign sheds light on the challenges of regulating emerging technologies with frameworks crafted for more conventional assets. Its repeal removes significant barrier for traditional financial institutions enabling them to offer crypto custody. This may well see all banks offering custody and exchange solutions.

However, this regulatory shift also comes with heightened responsibility particularly for those dealing in Bitcoin. Unlike some digital tokens that rely on corporate backers, governance structures, or mechanisms that allow additional issuance during a crisis, Bitcoin has no central authority to “bail out” failing systems. Banks and investors should be weary of bank business models that involve under-collateralized lending, and rehypothecation.

If a bank, exchange, or any large player misuses or loses customer Bitcoin, there is no built-in safety net. There is no central party that can mint extra coins, reverse transactions, or otherwise rescue the situation. This is quite different from traditional finance (or some other crypto projects), where a government or corporate entity might step in with a bailout, print more money, or forcibly rearrange the ledger. Bitcoin doesn’t have that kind of “emergency mechanism,” so if a crisis happens, it unfolds without a top-down rescue option. This calls for prudential custody and the avoidance of rehypothecation.

Excessive Financial Structuring & Rehypothecation

Rehypothecation is when financial firms reuse customers’ Bitcoin as collateral for their own trading and lending. We have seen this happen before and it has been proven disastrous in the crypto sector. The collapses of FTX, BlockFi, and Genesis all share a common thread: risky, under-collateralized leverage hidden behind arcane financial conjuring. If these practices were to be replicated on a larger scale, it may set the stage for financial crisis.

One practice worth emulating from the futures markets would be the segregation of customer funds and restrictions on their use for trading and lending.

A Path Forward
In addition to removing SAB 121’s hurdles to innovation, regulators would be advised to consider measures to prohibit rehypothecation of digital assets like Bitcoin. Such a safeguard would help ensure that banks and custodians maintain a fully reserved model, mitigating systemic risks and maintaining the core value proposition of Bitcoin’s fixed supply.

With clear regulatory boundaries that protect against excessive leverage, crypto custody could mature into an integral part of the financial system. It would also be one that fosters innovation without repeating the mistakes that have triggered so many crises in both crypto and traditional finance. The regulatory landscape for crypto is taking shape rapidly and its still only January 2025. It can strike the right balance between enabling growth and the paramount concern of safeguarding consumer assets.

Need Guidance? Contact Our Firm

For more information or specific legal advice, feel free to contact our firm. We regularly advise on regulatory compliance, securities law, and emerging issues in the digital asset arena. Our goal is to help clients navigate this rapidly shifting landscape responsibly and successfully.