California's Legal Challenge to Crypto Liquidation Practices: Regulatory Shifts and the Surge in Institutional Crypto Custody Demand

In 2025, California has emerged as a pivotal battleground for redefining the intersection of cryptocurrency and regulation. The state's recent legislative and legal actions-most notably Senate Bill 822 (SB 822) and the Digital Financial Assets Law (DFAL)-have not only reshaped the legal framework for unclaimed crypto assets but also catalyzed a surge in institutional demand for crypto custody services. These developments signal a broader shift toward balancing innovation with consumer protection, while creating new opportunities for custodians, exchanges, and institutional players.

The Regulatory Overhaul: SB 822 and DFAL

SB 822, signed into law by Governor Gavin Newsom on October 14, 2025, marks a historic milestone by explicitly classifying digital assets under California's Unclaimed Property Law. For the first time, unclaimed cryptocurrencies-those inactive for three years-are preserved in their original form rather than being forcibly liquidated into fiat. This law mandates that custodians notify account holders via standardized forms, retain assets in their native form for 18–20 months, and only convert them to cash if unclaimed, as Invezz reported. By aligning crypto with traditional unclaimed property (e.g., bank accounts), SB 822 addresses long-standing concerns about forced liquidation and unintended taxable events for consumers, as Decrypt reported.

Complementing SB 822, the DFAL-enacted in 2023 and extended to July 1, 2026-has introduced a comprehensive licensing regime for digital asset activities. Entities engaging in storing, transferring, or exchanging crypto must now obtain a license from the Department of Financial Protection and Innovation (DFPI), with stringent compliance requirements including anti-money laundering (AML) protocols, cybersecurity measures, and consumer disclosures, as Dechert notes. The DFAL also imposes reserve requirements on stablecoin issuers, ensuring they maintain eligible securities equal to their outstanding tokens, FinancialContent reports. These measures aim to standardize the crypto market while fostering trust in institutional-grade custody solutions.

Institutional Custody Demand: A New Era of Growth

The regulatory clarity provided by SB 822 and DFAL has directly fueled institutional demand for crypto custody services. According to Grand View Research, the global digital asset custody market is projected to grow at a 23.6% compound annual growth rate (CAGR), reaching $4.38 trillion by 2033. In California, this trend is amplified by the state's unique legal framework. For instance, Coinbase, a leading crypto-native custodian, reported over $245.7 billion in assets under custody as of mid-2025, per Glassnode.

Traditional financial institutions are also entering the fray. State Street and Citi, for example, have announced plans to offer crypto custody services, leveraging their existing infrastructure to meet client demand, as Blockhead reported. This shift is further supported by federal developments, such as the SEC's relaxation of SAB 121 rules, which now permit banks to engage in crypto custody without additional regulatory hurdles, as CoinDesk reported. The DFAL's emphasis on licensed custodians has created a fertile ground for institutional participation, with banks and crypto-native firms competing to secure market share.

Market Dynamics and Industry Responses

The DFAL's licensing requirements have spurred a wave of compliance-driven innovation. By July 2026, entities must either obtain a DFPI license or submit an application, prompting firms to invest in compliance infrastructure. For example, crypto ATMs in California now enforce daily transaction limits and mandatory disclosures, aligning with DFAL's consumer protection mandates, as Stinson reports. Meanwhile, DeFi protocols and stablecoin issuers face challenges in adapting to the state's stringent rules, potentially leading to market consolidation as smaller players struggle to meet capital and operational requirements, as Mayer Brown warns.

The legal landscape has also seen enforcement actions that underscore California's regulatory rigor. In a landmark case, the California Department of Justice secured a $3.9 million settlement with Robinhood for misleading customers about crypto withdrawal policies, the Attorney General's office announced, marking the first public application of state commodities laws to crypto. Such actions reinforce the state's commitment to holding platforms accountable, further incentivizing institutional players to adopt robust custody solutions.

The Road Ahead: Innovation vs. Regulation

California's regulatory approach exemplifies a delicate balance between fostering innovation and safeguarding consumers. While SB 822 and DFAL have created a more structured environment for crypto custody, they also introduce compliance costs that could deter smaller operators. However, the long-term benefits-such as increased institutional adoption, enhanced consumer trust, and a standardized market-position California as a national model for crypto regulation.

For investors, the surge in institutional custody demand presents compelling opportunities. As traditional banks and crypto-native custodians vie for dominance, the market is likely to see further consolidation and technological advancements in security (e.g., multi-party computation, cold storage). Moreover, the DFAL's conditional reciprocity with New York's BitLicense regime could facilitate cross-state compliance, enabling national expansion for compliant firms, as Paul Hastings notes.

Conclusion

California's legal challenge to crypto liquidation practices has redefined the regulatory landscape, driving institutional demand for custody services and setting a precedent for national frameworks. As the state continues to refine its approach-through public feedback, licensing adjustments, and enforcement actions-it solidifies its role as a leader in the digital asset ecosystem. For investors, the intersection of regulatory clarity and institutional adoption offers a unique window to capitalize on the evolving crypto custody market.