Fed scrutiny on crypto banking is a gift to giants like BlackRock — and more oversight may be coming

The US is getting serious about regulating crypto in banks.

The Federal Reserve just announced a plan to bring new scrutiny to “novel activities” — including a range of crypto-related services — performed by the big banks it oversees.

The Fed and the US’s other banking watchdogs have warned banks away from getting involved in crypto, triggering fears in the industry that the government is moving to cut it off from crucial services like bank accounts.

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

This new programme formalises this ad hoc approach and signals that more bank scrutiny is coming, Akash Mahendra, a director at the Haven1 Foundation and a portfolio manager at Yield App, told DL News.

But, he said, it could have been worse — the Fed didn’t ban banks engaging with crypto outright.

For Mahendra, this is a sign that federal regulators are smoothing the way for more institutional involvement in this space.

That could mean approvals are on the way for Bitcoin and Ethereum ETFs, he said.

“Through the process of legitimation, traditional financial institutions are inclined to explore and adopt crypto,” he added.

Asset management giant BlackRock is awaiting a nod for its Bitcoin spot ETF, as are a clutch of other finance giants including Fidelity and Ark Invest.

That has fuelled speculation about an institutional land grab of crypto. Critics fear a crypto crackdown hurts smaller players and helps giants who have armies of compliance and legal teams, ample political connections, and lobbying firepower.

While big banks and asset managers have over the years made significant investments into crypto trading and experimenting with blockchain technology, the risks have deterred them from jumping in with both feet.

READ NOW: Bonds on the blockchain: B2C2′s CEO on what crypto can learn from TradFi

Cryptocurrencies present unique challenges to banks, Mahendra said, as they are inherently high risk and susceptible to volatility.

“Banks that house consumer and business funds straddle both public utility and commercial dimensions. While these risks are manageable, they require meticulous handling, and regulators are now vigilant,” he said.

The Fed is seeking to put in appropriate guardrails, he said, saying the emphasis on supervision rather than an outright ban reflected a “favourable outcome for consumers and serving as a substantial victory for the fintech sector.”

What does the programme do?

The programme focuses the Fed’s attention on the relationships banks have with crypto businesses, such as providing bank accounts or payments.

It also scrutinises the activities banks themselves might perform as part of their lending businesses, such as trading cryptocurrencies, or using crypto as collateral for loans.

And it will focus on banks’ exploration of blockchain tech for activities like tokenisation of securities.

In a related release, the Fed also said that state-chartered banks wanting to issue, hold, or transact with payment stablecoins must first prove they can manage risk, including cybersecurity and illicit finance risks.

NOW READ: ‘Tether is next’ says short seller who bet against Silvergate and Signature Bank

“The goal of the novel activities supervision programme is to foster the benefits of financial innovation while recognising and appropriately addressing risks to ensure the safety and soundness of the banking system,” the Fed said.

Prohibited Activities

In January, the Fed and the US’s other banking authorities, the Federal Deposit Insurance Corporation and the Treasury’s Office of the Comptroller of the Currency, made it clear they are worried that crypto presents novel risks to the financial system.

They also clarified that state-chartered banks could not engage in activities prohibited to federal banks, and that would apply to state banks wanting to hold crypto or stablecoins.

These statements came as the Fed blocked crypto bank Custodia’s application for a federal charter, saying its risk management practices weren’t robust.

Not long after, three crypto-friendly banks — Silicon Valley Bank, Silvergate and Signature — all folded.

These events, along with an intense crackdown from regulators, seemed to many in the industry to amount to a sustained, coordinated attack on crypto — dubbed Operation Choke Point 2.0.

READ NOW: Litigator who challenged Operation Choke Point rallies crypto to fight ‘illegal’ regulatory crackdown

Stablecoin murkiness

Other commentators were less optimistic about the Fed’s new programme, saying it could push the crypto industry abroad.

Jon Egilsson, chairman and co-founder of digital currency company Monerium and a former chairman of the supervisory board of the Icelandic Central Bank, said the Fed appears to be reacting to the mainstream adoption of stablecoins.

As DL News reported, payments provider PayPal this week launched a dollar-backed stablecoin, a vote of confidence in the concept.

NOW READ: French regulators race to get a jump on MiCA and make Paris Europe’s web3 hub

But the US’s approach is not proactive, Egilsson said. Rather than merely providing guidance in response to the mainstream adoption of stablecoins, Congress and regulators should provide clear rules.

In Europe, MiCA and other rules offer time-tested, tech-neutral frameworks for regulating stablecoins, he said.

A second eurodollar market

“If the US doesn’t establish a clear regulatory framework for stablecoins like Europe already has, the market might simply shift to jurisdictions that recognise the permanence of web3 technology,” Egilsson said.

READ NOW: Stablecoin laws could give US an edge — if they ever get off the ground

He said a similar phenomenon has happened before. In the 1960s, a lack of clear rules in the US resulted in US dollars being held in deposit accounts at European banks. These so-called eurodollars began to be used extensively in international finance, but because they were held offshore, they were outside of the Fed’s oversight.

“Perhaps we are witnessing the emergence of a second eurodollar market, driven this time by the lack of regulatory clarity in the US for USD stablecoins,” Egilsson said.

Do you have any opinions on crypto reg you’d care to share? Email me joanna@dlnews.com or find me on Telegram @joannallama.