The Biden administration released a new roadmap to “mitigate cryptocurrencies’ risks” on January 27th, and the same day the Board of Governors of the Federal Reserve System announced the decision to deny cryptocurrency-friendly Custodia Bank membership in the Federal Reserve System. Later in that same afternoon, American Banker reported that the Federal Reserve Bank of Kansas City also denied Custodia Bank’s application for a master account.
While the events were certainly a disappointment for shareholders of Custodia Bank, they were widely expected and there are glimmers of hope for digital asset market participants. The decisions for Custodia were specific to the bank, and not rejections of cryptocurrency. The tone from the White House blog appears to be more cautious than previous communications, but the positive message was that they “have spent the past year identifying the risks of cryptocurrencies and acting to mitigate them.” This approach is unlikely to satisfy cryptocurrency proponents who want clear leadership within the crypto markets so that it can continue to grow within the regulatory structure that makes the U.S. the world leader in financial markets.
White House Blog Does Not Designate Leader
The administration wrote that their “focus is on continuing to ensure that cryptocurrencies cannot undermine financial stability, to protect investors, and to hold bad actors accountable.” These are laudable and non-controversial goals, but the conflicts will arise because there will continue to be considerable disagreements on the methods used to accomplish those objectives.
The administration has instructed agencies to “ramp up enforcement where appropriate and issue new guidance where needed.” This is a half-measure. There will be few that disagree that new guidance is necessary, and that enforcement against bad actors is a good thing. The important question left unanswered is who is in charge?
One strength of the American financial services industry is the overlapping system of regulatory agencies with multiple points of oversight. This feature of our system can also be a weakness when it is unclear who should be taking a leadership position. The Federal Reserve appears to be taking the lead for the interaction of digital assets and banking, and that is a great step forward. The administration should also clarify which agency they believe should take point for broader regulation, and then support that agency with the full weight of the executive branch.
The Commodity Futures Trading Commission (CFTC) is working with bitcoin and ethereum as commodities, and they are seeking to regulate the entire space. Similarly, the Securities and Exchange Commission is seeking to become the lead regulator for the asset class – with the exception of those assets designated commodities. The digital asset class is so broad that certain assets are commodities, and other are clearly securities. It is the great section in the middle that requires additional attention, and most likely specific rules and regulations to address the characteristics of the asset class.
Existing Laws Work
The White House called for Congress to act, but outside of providing greater budgets for the regulatory agencies it is unclear what new legislation is required. The laws in the U.S. regarding financial services were purposely written broadly enough to accommodate future innovations, including cryptocurrency, and the agencies have the ability to expand rulemaking to accommodate new innovations. Perhaps the quickest way for the administration to meet their stated objectives is to continue to make clear who they support to be in charge.
At the beginning of last month, on January 3, the big three banking regulators issued a joint statement on crypto-asset risks to banking organizations. The Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) listed a number of key risks, and cautioned that “risks that cannot be mitigated or controlled do not migrate to the banking system.” This is the same message coming from the White House.
Perhaps to most important part of the release, at least to Custodia Bank, was that statement that “issuing or holding as principal crypto-assets that are issued, stored, or transferred on an open, public, and/or decentralized network, or similar system is highly likely to be inconsistent with safe and sound banking practices.”
That announcement was effectively a prohibition against banks holding cryptocurrencies on the balance sheet as an asset, or issuing a bank stablecoin. The Federal Reserve rejection noted Custodia Bank’s “novel business model and proposed focus on crypto-assets presented significant safety and soundness risks.”
As the banking regulators evolve their understanding of the risks and benefits of digital assets that policy will likely be modified, but for now it does effectively close out any efforts of chartered banks to expand into the stablecoin market.
The evolutionary pathway for the existing financial services industry to embrace digital assets will include various authorities in the U.S. who are normally slow and cautious. This approach has served well in the past, but in a digital world where everything is moving faster than ever, a greater sense of urgency would be welcome. There will be no “right” answer for how mitigate or control every risk and hence no best way to regulate cryptocurrency. Nevertheless, the market will welcome a strong voice from the administration to provide leadership.