Blythe Masters, a trailblazing UK private equity and fintech executive, called blockchain ‘the financial challenge of our time that’s going to change the way our financial world operates.’ Charlie Lee, founder of Litecoin, a cryptocurrency with an $8 bn market cap, says ‘cryptocurrency is so powerful, it can almost overturn governments.’ These fighting words foreshadow the inevitable bout between the 21st century innovators and the 20th century US regulatory agencies: they’ve donned the boxing gloves and are ready for multiple rounds.
In the aftermath of the FTX bankruptcy, a crypto banking crisis and a possible ‘burn-it-all-down’ regulatory stance, growth might be on the rails for the crypto asset industry, stretching out the timeline for integration with traditional finance. In the blink of a few days in early March, two of the most prominent banks serving crypto companies disappeared, disrupting a business lifeline for a few hundred US crypto exchanges and legions of start-up and venture-backed companies, institutional investors and funds, as well as public companies transacting with crypto-currencies.
It started on March 8 with the voluntary liquidation of California-based Silvergate Bank. Founded in 1988, the NYSE-listed bank with $11 bn in assets had been cultivating crypto companies since 2013. FTX was one of its biggest clients and its fall last November triggered the attention of regulators and the concern of creditors and clients, resulting in a devastating bank run. After being forced to sell off securities at a huge loss, management decided its only option was to wind up operations, returning funds to depositors.
Then on March 10 Silicon Valley Bank crashed, causing havoc for some of its blockchain clients, including Circle, whose $3.3 bn exposure backing its USDC stablecoin caused a temporary investor retreat and de-pegging from the US dollar. Then two days later the New York Department of Financial Services announced it had seized Signature Bank – the other crypto-friendly bank – with assets of $114 bn and a quarter of its business devoted to crypto companies. The reason was fear of continued contagion and withdrawals in the banking sector, but some found the reason for its shuttering more mysterious.
Sending a message
Signature was not insolvent, according to board member and ex-Congressman Barney Frank, famous for the Dodd-Frank Act that tightened banking regulations post-2008; he told CNBC it was done so regulators could send a message to get people away from crypto. Multiple lawmakers sent letters to banking regulatory agency heads echoing this concern. Widespread industry outrage ensued with many expressing social media opinions that the banking crisis was being ‘weaponized’ to kill crypto, which regulators have denied.
The knockout of the two key crypto banks delt a huge blow to how money moves in and out of the crypto world. The Silvergate Exchange Network and Signature Bank’s Signet platform both revolutionized the ease of doing business by providing instant 24/7 payments and settlement required by business clients for crypto/fiat transactions. Curiously, the sale of Signature’s assets by the Federal Deposit Insurance Corporation (FDIC) to new owner Flagstar Bank did not include the Signet network. Companies are now challenged to find new banking relationships offering the same capabilities and large network; the crypto banking ecosystem just got pushed back to its 2018 stage.
On January 3, the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency (OCC) came together to issue an ‘inter-agency statement’ regarding their concerns about the risks of crypto assets over the last year, including risks to ‘stability and soundness’ of banking institutions, concerns with custody, fraud, contagion and stablecoin-run risk – concerns also shared by the industry’s many legitimate and lawful crypto asset companies.
Crypto industry concern
Since January, there’s been growing industry concern about Operation Choke Point 2.0, a phrase coined by Nic Carter, founder of Castle Island Ventures. He thinks the present government administration, the FDIC, the Federal Reserve and the OCC are using the banking sector to ‘organize a sophisticated widespread crackdown on the crypto industry’, a desire held well before the FTX debacle.
David Thompson, partner at law firm Cooper & Kirk, wrote a white paper claiming history is repeating itself, connecting this to his litigating experience 11 years ago during Choke Point 1.0. ‘The Obama administration used its regulatory powers and persuasion to target industries it didn’t like,’ he wrote – starting with gun stores, then payday loan lenders, tobacco shops and others.
The crypto industry is often frustrated with regulators. In January, Wyoming’s Custodia Bank was denied a national bank charter after waiting more than 18 months, having long ago received state authorization. It plans to litigate. Last year the SEC issued staff accounting guidance for lenders and custody providers that hold crypto tokens on behalf of clients, requiring them to be held on their balance sheet as liabilities and requiring banks to hold cash against this.
The edict came without any consultation, says Diogo Mónica, president of regulated custody provider Anchorage Digital, and put business with every one of his banking partners on hold, due to the capital cost being ‘completely unsupportable’.
There are currently multiple lawsuits against regulators and more are expected, which will help iron out further clarity on banking matters, but it will take time. On what to expect over the next year, law firm White & Case wrote in a recent update that in the absence of legislative direction, the banking industry is faced with ‘a limited set of crypto asset activities they may engage in; most require pre-approval or non-objection by the agencies.’
Sheila Warren, CEO of the Crypto Council for Innovation, told Decrypt that a denial of banking access ‘would mark a sea change for the approach to innovation and entrepreneurship in the US, signaling that the US is choosing not to be competitive in the tech space and would prefer that unregulated parts of the economy and other countries lead.’
Linda Montgomery is a Toronto-based fintech and digital assets marketing executive and an IR professional