In response to “significant volatility and exposure of vulnerabilities in the crypto-asset sector” throughout 2022, on January 3, 2023, the Federal Reserve Board (“FRB”), Federal Deposit Insurance Corporation (“FDIC”) and Office of the Comptroller of the Currency (“OCC”) (together the “Agencies”) released a joint statement (the “Statement”) highlighting risks to banking organizations related to crypto-assets and reiterating that banking organizations should ensure that crypto-asset-related activities are conducted in a safe, sound and legally compliant manner. The release of the Statement comes in light of the recent turmoil in the crypto industry and is likely part of the regulators’ response to the failure of FTX, a large crypto-asset exchange, and the subsequent fallout. It also identifies the susceptibility of stablecoins to run risk, in apparent reaction to recent stablecoin volatility and the May collapse of the stablecoin TerraUSD, which we discussed in a previous blog post. Since the failure of FTX, the OCC included a special section on the risk of crypto-assets to banks in its Semiannual Risk Perspective Report, and the Securities and Exchange Commission (“SEC”) has requested public companies to provide additional disclosure of their crypto-asset activities, as discussed in our previous blog post.
Some of the key risks the Agencies mention include the “[r]isk of fraud and scams among crypto-asset sector participants,” the risk of deposit outflows from banks holding stablecoin reserves and contagion risk within the crypto-asset market. The Agencies also note safety and soundness concerns related to a banking organization’s concentrated exposure to crypto-assets or crypto-asset-related activities. Regulators have previously discussed many of these risks, including, for example, in a recent report by the Financial Stability Oversight Council (“FSOC”) discussed in our previous blog post.
Notably, the Statement includes the Agencies’ view 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.” This admonition reveals the increased skepticism among the Agencies regarding the above-described activities, and likely portends additional scrutiny of prior notices from banks to the Agencies regarding new activities.
The release of the Statement reflects an emerging shift in the federal government’s tone from attempting to balance risks and benefits of crypto-assets to more directly expressing concern over risks. For example, the fact sheet accompanying President Biden’s Executive Order on digital assets discussed “addressing the risks and harnessing the potential benefits of digital assets and their underlying technology.” (For more information, see our post on the Executive Order.) Similarly, in releasing FSOC’s report, Treasury Secretary Janet Yellen discussed the importance of “mitigat[ing] the financial stability risks of digital assets while realizing the potential benefits of innovation.”
By contrast, the Statement does not mention potential benefits of digital assets and instead admonishes that risks related to the crypto-asset sector that cannot be mitigated or controlled should not be allowed to “migrate to the banking system.” In this context, the Statement highlights the Agencies’ “case-by-case” and “careful and cautious” approach to banks’ crypto-asset activities and notes that each of the Agencies has developed processes for banking organizations to engage in “robust supervisory discussions” regarding existing or proposed crypto-asset-related activities. The Statement references the Agencies’ previous guidance requiring banks to notify (and, in the case of the OCC, receive confirmation of non-objection from) the Agencies prior to engaging in crypto-asset related activities. We note that the New York Department of Financial Services also recently issued guidance requiring similar prior approval before engaging in crypto-asset related activities (as discussed in our previous blog post).
While the Statement does not allude specifically to any impending rulemaking on the part of the Agencies, and, as discussed above, highlights their “case-by-case” approach to crypto-asset-related activities, the Statement does mention that “[a]s warranted, the agencies will issue additional statements related to engagement by banking organizations in crypto-asset-related activities.” We note that additional volatility and upsets in the crypto-asset market may increase pressure on financial regulators, including the Agencies, to take more aggressive steps towards regulating crypto-assets.[1]
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[1] In the week following the failure of FTX, Senators Elizabeth Warren and Tina Smith sent a letter to FRB Chair Jerome Powell requesting regulatory action, noting specifically that “[w]hile the banking system has so far been relatively unscathed by the latest crypto crash, FTX’s collapse shows that crypto may be more integrated into the banking system than regulators are aware.”
