Compilation of the original text: Mary Liu, Bitui BitpushNews
Compilation of the original text: Mary Liu, Bitui BitpushNews
Crypto banking is a mess, with a storm on the FTX exchange causing devastating runs on two U.S.-regulated banks. Among them, Silvergate Capital Corp. had to sell assets at a loss to repay depositors and lenders, and Silvergate Bank declined. Voyager Digital went bankrupt and urgently warned customers that their deposited funds were not protected by the Federal Deposit Insurance Corporation (FDIC).
U.S. regulators are pressuring banks to stop banking crypto platforms and exchanges. In a decision that has rocked the crypto industry, the U.S. Federal Reserve has rejected membership applications from Custodia Bank, a fully-funded reserve bank that provides payment and custody services to cryptocurrency businesses.
What's next for banking related to cryptocurrencies?
On January 3, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Overseer of the Currency (OCC) issued a joint statement to banking institutions on the risks of encrypted assets, and the regulatory crackdown on encrypted banks officially began. We wonder why they decided to sever the link between the crypto ecosystem and the dollar system until now, 14 years after Bitcoin and 9 years after Tether first appeared.
But the answer is in their statement: "The events of the past year have been marked by dramatic volatility and exposure of vulnerabilities in the cryptoasset space, which have highlighted some of the key risks associated with cryptoassets and cryptoasset industry participants that banking institutions should be aware of. .”
They went on to give the risks they see in the current crypto ecosystem: fraud and scams; legal uncertainty; inaccurate or misleading marketing (including claims to have FDIC insurance) and “other potentially unfair, deceptive or abusive cryptocurrency market volatility; risks associated with stablecoin reserves; contagion risk due to extreme interconnectedness; poor risk management and governance; hacking and cyberattacks; There is a general increase in risk.
“It is important that unmitigated or controllable risks associated with the crypto asset sector are not transferred to the banking system,” they warned.
The message is clear. U.S. regulators see cryptocurrencies as a serious threat to the traditional financial system. Not because it's going to take it over, but because it might bring it down.
For all the chants about “unbanking yourself,” cryptocurrency exchanges, lenders, and stablecoin issuers need access to banks. With the exception of physical notes and coins, all dollar-denominated transactions pass through the U.S. banking system and are ultimately settled on the books of the Federal Reserve Bank of New York. Fintech payment apps such as Venmo and Zelle create the illusion that dollar payments can be made without the involvement of banks. But digging deeper into these companies reveals that they depend on a network of banks — Zelle, in fact, is owned by a consortium of banks, as are international dollar payments.
Contrary to popular belief, international payments are not sent via SWIFT: SWIFT is just a messaging service. Instead, like domestic payments, international dollar payments are sent and received by banks and settled through the books of the New York Fed. Therefore, it is impossible for any cryptocurrency company, regardless of whether it has operations in the United States, to accept or pay fiat dollars unless it has a direct or indirect relationship with a US bank.
Cryptocurrency companies also use banks to store cash reserves that “back” customer deposits. But it's not strictly necessary: they could use money market mutual funds, or hold short-term U.S. Treasury bills, for example. It’s also odd that crypto companies like to claim that “unlike banks” they hold full reserves on customer deposits. However, this argument does not hold if reserves are held in fractional reserve banks.
It’s hard not to conclude that the real reason many cryptocurrency companies hold cash in the bank is so they can tell depositors they are FDIC insured. The FDIC has issued cease and desist orders to a number of companies, including exchanges FTX and CEX, for falsely stating or implying that FDIC insurance applies to their customer deposits.
However, while payments and custodian services are important banking functions, they are less important than traditional business models. The business model of traditional banks is to borrow at low interest rates, lend at high interest rates, and then earn the difference. Traditional banks are important liquidity creators and distributors, not only in financial markets, but in the wider economy. As the US discovered after the collapse of Lehman Brothers in 2008, when banks stop lending, the economy stalls. The crypto industry initially avoided borrowing, but quickly discovered that without it, the ecosystem was not sufficiently liquid. When HODLing a lot and borrowing a little, liquidity is gold.
The U.S. dollar is illiquid in the crypto ecosystem, so crypto companies don’t need lending services from traditional banks. And because they may have to pay those scarce fiat dollars on short notice, they want any funds they deposit with traditional banks to be held in custody and not used as liquidity for the bank's other activities. Therefore, cryptocurrency companies want a type of bank that we don't currently have: "full reserve" banks. In 2019, Wyoming created a full reserve bank charter, and its “special purpose depository institution” (SPDI) can take deposits and provide asset management, custody and related services, but cannot lend (although it can buy certain types of debt securities ) and must maintain unencumbered liquid assets of at least 100% of their total deposits.
Custodia Bank is an SPDI in Wyoming. It does not lend, but provides payment and escrow services:
“Custodia has all the benefits of being a bank with expertise in digital assets — plus, as a depository institution, we qualify to interface directly with the Fed payments system, eliminating middlemen and layers of fees.” Specifically:
U.S. banks with direct access to the Fed through a master account can clear payments for their clients directly at the Fed, reducing the costs, delays, reconciliation headaches, and counterparty risk involved with traditional intermediaries
Banks are defined as "qualified custodians" under the Investment Advisers Act and the SEC's custodian rules
Banks are defined as "good control platforms" under the SEC's customer protection rules.
A fully-reserved, non-lending bank earning a profit solely on fees for payments and escrow services sounds like a smart solution for crypto banking needs. In fact, many might argue that it has broader applications as well — after all, it’s not just cryptocurrency companies that need safe places to park their savings. If it's 100% reserved, there's no risk of a bank run, and if it doesn't lend, it won't become insolvent with bad debts. Although deposits in Custodia are not FDIC insured, they are completely safe. So why did the Federal Reserve refuse to accept Custodia as a member and refuse its direct participation in dollar clearing?
The problem is not Custodia, but the customer. Custodia specializes in banking and custody services for crypto businesses. The Fed’s view of these is not just mildly biased, it sees the entire crypto industry as a breeding ground for financial crime. It will hardly give the green light to a bank that, in its view, is primarily in the business of helping high-risk businesses, and in the worst cases actually criminal businesses, to store and move dollars.
There is a second problem: Custodia plans to issue its own token. The token will be a liability of Custodia convertible at par into dollars — a “tokenized dollar.” It will be fully reserved and Custodia has applied for FDIC insurance. It seems like a good idea for a regulated bank to issue a fully reserved, FDIC-insured tokenized dollar that can be used on multiple blockchains. This will make the dollar much more liquid in the crypto space and reduce reliance on companies like Tether. The problem is not with the token, but with the network.
Custodia plans to issue tokens on Blockstream's Liquid network and possibly Ethereum. These are public decentralized networks. Custodia has no control over the ownership and distribution of such Tokens. It's as if it issued its own currency. Issuing tokens on such networks "is likely to be inconsistent with safe and secure banking," said the joint regulator statement cited above. While regulators see cryptocurrencies as tools for money laundering, terrorism financing, and ransomware, and headlines are dominated by cryptocurrency-related scams, scams, and scams, regulated banks will not be allowed to issue on public networks stablecoins.
If crypto companies stop fighting regulators and turn around, the Fed may look more favorably on the banks that serve them. But anyway, I don't believe Custodia's business model makes commercial sense. The reason we don't have full reserve banks is that they are inherently less profitable than their fractional reserve competitors. Historically, full-reserve banking never lasted long: Banks either found ways to leverage customer deposits, were bought by fractional-reserve banks, or failed.
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