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Bank regulators won’t ban crypto, they’ll ‘starve’ it

Bank regulators won’t ban crypto, they’ll ‘starve’ it
Banking regulators have made a series of moves in the shadow of the SEC grabbing headlines.

The Securities and Exchange Commission’s recent regulatory crackdowns on crypto have riled the industry. However, it is the nation’s banking regulators, not the SEC, that will determine the sector’s future.

That is according to lawyers who say the Federal Reserve, Federal Deposit Insurance Corporate, and the Office of the Comptroller of the Currency’s recent string of cautions and law enforcement actions suggest that they are slowly bringing crypto under their thumb.

They note that banking regulators have made a series of moves in the shadow of the SEC grabbing headlines with its subpoena of Robinhood, ordering Kraken to dismantle its staking business and telling Paxos to stop minting the Binance USD stablecoin.

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Those moves suggest that the Feds want to close off the industry’s on- and off-ramps – the banks enabling companies to convert their crypto to fiat money and vice versa – the lawyers say.

“I don’t think the US wants to ban crypto,” Eric Hess, founder of Hess Legal Counsel, told DL News. “It just wants to starve the existing ecosystem and have various players die out or have to significantly curtail and then reshape their businesses.”

Blocking the on-ramps

While the SEC is a markets regulator, the Fed, FDIC and OCC are what are known as “prudential” regulators. They ensure that banks control risk and hold enough capital to withstand systemic shocks to the financial system.

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Last week, the Fed, FDIC and OCC issued a warning to banks on liquidity risks related to cryptocurrency.

The guidance just tells banks to be aware of crypto-specific risks with regard to the assets they hold as deposits.

The guidance followed a joint statement from the Fed, FDIC and OCC in early January that warned of the risks of crypto contagion on the rest of the financial system. The statement said they would strictly review any company wanting to register as a bank to engage in crypto asset-related activities.

Later that month, the three agencies issued a policy statement that aligned their position on crypto. The statement said that banks with state licences could not engage in activities prohibited to federally-licensed banks, and that would apply to state banks wanting to hold crypto assets or stablecoins.

In January, the Fed also blocked crypto bank Custodia’s application to join the Federal Reserve system, saying the bank has insufficient risk management practices. In response, Custodia has amped up its ongoing lawsuit against the Fed, saying the central bank’s actions could put it out of business.

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The moves represented part of a pivot of sorts for the OCC, which had seemed relatively friendly to crypto. In 2020 and 2021, it authorised a small number of cryptoasset activities as being safe for national banks, including some stablecoin-related activities.

The agency began to back away from this stance, however, in 2021, and 2022 ended any expectations of mercy for the industry, as stablecoins Terra USD and Luna collapsed, and FTX failed.

“Right now there’s the SEC story. But the OCC story is more significant. It impacts policy in a much more direct way,” Hess said.

‘Right now there’s the SEC story. But the OCC story is more significant’

‘Irresponsible’

Karen Solomon, senior of counsel at Covington, told DL News that the three agencies see it as irresponsible to leave assets that are not well understood outside of their grasp.

“Deciding whether to allow a brand new asset class – cryptocurrency and related activity – into the regulated space is an enormous challenge for regulators because the relative novelty of cryptocurrency means that regulators can’t predict how it will behave in crisis situations,” she said.

Solomon was formerly acting senior deputy comptroller and chief counsel at the OCC.

She said that crypto being brought into the fold of big banks will be key to its survival in the US. One way to deal with uncertainty around crypto is to allow its careful, controlled entry into the realm of firms that are already regulated, and then to carefully calibrate supervision to the characteristics of the asset, Solomon said.

“Regulators have tools to tailor their supervision to the activity, and the experience they gain in supervising cryptocurrency activities would enable them to develop more generally applicable standards and policies over time,” she said.

“It may actually be preferable for regulators to take on that challenge, rather than to allow crypto currency to evolve unsupervised beyond regulators’ direct influence.”