A joke making the rounds in the financial industry is that cryptocurrency is the only disruptive technology that has managed to disrupt itself, and in the absence of federal regulatory guidance, don’t expect community banks to get involved in “crypto” any time soon.
Given the disruption of the past year, including criminal charges against industry executive Sam Bankman-Fried, who was charged with defrauding customers of billions of dollars and put on trial last month, it’s really no laughing matter. With the sudden collapse of Bankman-Fried’s FTX Trading Ltd. and other crypto companies, banks in Wisconsin and elsewhere have been advised to take a breather on crypto, whether or not they had plans to offer their own related products and services.
There are several reasons for banks to be in a holding pattern when it comes to engaging with cryptocurrency companies or offering their own products, including:
Reason 1: Bankman-fraud
The events of the past year have not exactly compelled depositors to demand crypto. The first alarming development was the indictment of Bankman-Fried, which led to the multibillion-dollar collapse of FTX in November 2022. If allegations of mismanagement weren’t enough, quarterly losses hit Bitcoin, Ether, and other crypto tokens, and more alarm bells went off after reports from Canada indicated that even with encryption, cryptocurrencies are being targeted by cybercriminals who view the digital asset as both target and a tool.
Earlier this year, Federal Reserve Governor Christopher Waller warned U.S. banks interested in crypto to proceed with caution. He specifically cited anti-money laundering requirements in federal law, noting that banks engaging with crypto companies would have to fully understand their business models, risk-management systems, and corporate governance. The Fed has launched a new program to oversee banks’ crypto activity, emphasizing another requirement that lenders under its authority get approval before engaging in business activities involving digital assets.
Reason 2: Lack of definition
Another uncertainty is a matter of definition. Digital currencies are a type of monetary exchange used in electronic payment transactions, but they are not considered “regular money” issued or backed by the federal government or the Fed, the nation’s central bank. Digital currencies are stored in digital wallets, which is software installed by users on their computing devices, and each digital wallet contains encrypted information that is used to send and receive digital currency.
Banks may or may not be involved in the process because digital currency transactions are recorded on a virtual public ledger called the blockchain, which is maintained by people who are awarded digital currency such as Bitcoin in exchange for verifying transactions and adding them to the blockchain. However, if banks get the regulatory green light, they could opt to establish partnerships with cryptocurrency companies or offer their own crypto products.
Since crypto is viewed as both an investment and as a commodity, especially by the public, there is some confusion as to which federal agency should have jurisdiction. “Even the FDIC [Federal Deposit Insurance Corp.] and the regulators are questioning what cryptocurrency is,” says Jim Tubbs, president and CEO of Lake Ridge Bank. “Is it a currency or is it an investment? If it’s a currency, then it would be regulated and managed by the U.S. Treasury. If it’s an investment, then it’s regulated and managed by the SEC. Even Washington hasn’t yet determined which direction it’s going, hence the confusion that so many people have and obviously why many of us are standing on the sidelines waiting to see.”
Reason 3: It’s still just a bill
Thirty-nine U.S. states, plus Puerto Rico and the District of Columbia, have introduced legislation to regulate crypto, but with no law in place in Wisconsin and with no laws to codify federal oversight, there simply isn’t enough regulatory guidance for financial institutions to proceed. With the industry operating in a regulatory gray area, the U.S. Securities and Exchange Commission (SEC) has become more active in regulating cryptocurrencies as securities rather than commodities, noting they are subject to investor protection rules.
Meanwhile in Congress, the House Financial Services Committee has advanced a bipartisan bill to define when a cryptocurrency is a security or a commodity — the latter is a definition supported by most crypto companies. The legislation also would expand the Commodity Futures Trading Commission’s (CFTC) oversight of the crypto industry and clarify the SEC’s jurisdiction.
The committee also advanced a bill to regulate stable coins, a type of cryptocurrency usually pegged to a traditional asset such as the dollar. Under the bill, the Fed would write requirements for issuing stable coins while preserving the authority of state regulators.
Rose Oswald Poels, president and CEO of the Wisconsin Bankers Association, says the WBA has not issued any specific guidance on cryptocurrency to its member banks, but does support stronger federal regulation around stable coin. “When it comes to giving our members specific advice with regard to cryptocurrency, we have not because the regulators have been highly critical and highly inquisitive of any bank that even tries to touch this space,” she notes.
As for the stable coin bill, the WBA opposed it because it did not provide any construct for federal regulation. Oswald Poels says there is a regulatory role for states to play in a dual banking system, but in this case lawmakers proposed that regulation for any kind of stable coin be done only by the states. “There was no federal oversight, and that, we believe, is a problem,” states Oswald Poels. “There is obviously a lot of federal oversight of the banking industry, even for those that are state-chartered institutions. So, they follow more state laws than federal, but there’s always still federal oversight of those banks and federal examination of those banks.
“So, we believe the same thing should happen with stable coin, which is really intended to function across state lines, across country lines, and basically function in the global environment. There needs to be some larger oversight than simply one state regulator.”
Also from an advocacy standpoint, the WBA is on record opposing the Fed’s digital currency concept because of its potential impact on depositors. Based on the concepts that WBA has seen with regard to a central bank digital currency, the association believes it would act in a way that takes customers away from the banks. “They’re inserting themselves as a direct vendor to the public and to people individually as opposed to the banking industry, where the banks are the intermediary between the Fed and the public.”
Reason 4: Failure is not an option
After the bank failures earlier this year, at least one of which was related to crypto, suspicion is more intense. The trial of Bankman-Fried, which revealed a secret cash conduit used to withdraw billions of dollars from customer funds, offered a sober reminder of industry failings, so the lessons of the past year are still fresh in the minds of bank regulators.
“Certainly, the Signature Bank failure can be tied to the FTX exchange collapse and other cryptocurrency business that they were too heavily engaged in,” Oswald Poels states. “So, diversification of a bank’s business line, both in terms of their loan portfolio as well as their deposit funding sources, is very much scrutinized by regulators.”
Reason 5: Moving on
Before the controversies of the past year, many banks were getting ready to use crypto like a currency, but now they are more focused on leveraging the latest shiny object — artificial intelligence — and their attention has turned to AI.
“At this stage in the development of a [crypto] payment system, this is all still too new,” Oswald Poels notes. “We’re still a bit on what I would call the Wild West frontier when it comes to cryptocurrency. There’s still so much fraud involved. It’s not a stable investment … and so much of the criminal element is still involved in cryptocurrency today that it’s just really risky both as an investment or as a commodity.
“That could change in the future,” she adds, “but it’s still too early.”
