Published on Dec 17, 2021
Federal officials concerned that the cryptocurrency industry needs urgent oversight are developing plans to let banking regulators use their existing powers to examine crypto companies when they partner with traditional banks, according to financial and regulatory sources familiar with the thinking.
U.S. bank regulators have the authority to examine—and fine—contractors and other outside companies that deliver services to banks.
Although those powers have traditionally been used in a limited way, officials at the Federal Reserve and the Office of the Comptroller of the Currency (OCC) have in recent months determined that banking rules can help curb risks in the unregulated crypto asset market, whose value has exploded to more than $2 trillion worldwide.
“We have some power to lean on crypto now,” said one bank regulatory official. “There will be some howls, but there is also a sense that we need to get creative.”
The plans are taking shape as lawmakers grapple with how to bring digital assets such as Bitcoin and related exchanges and payment providers into a regulatory framework that would both protect consumers and encourage innovations that could make financial transactions faster and less costly.
In recent months, some leading regulators have asked staff members to outline a legal rationale for examining the crypto industry, said the sources.
Companies in the business open themselves to examination when they work closely with banks in the payments space or jointly promote stablecoins, staff at the Fed and OCC have concluded, said the sources. Stablecoins are digital coins pegged to traditional currencies or commodities, such as gold. They were conceived as a bridge between cryptocurrency and the U.S. dollar.
Cryptocurrency exchange Coinbase Global (COIN) has struck at least two partnerships with banks. Coinbase Card, a debit card linked to a customer’s Coinbase account, is issued by South Dakota-based MetaBank which is regulated by the OCC. Coinbase also has ties with Cross River Bank which holds a New Jersey bank charter and has deposits backed by the Federal Deposit Insurance Corporation (FDIC).
Coinbase declined to comment on its ties to banks and the enforcement powers of regulators.
Bank regulators routinely scrutinize technology companies that support bank functions, and they have good reason to ask whether their existing powers could be used to police the growing crypto market, said Lee Reiners, a former Fed examiner who now teaches at Duke Law.
“The stakes are high, if you believe that crypto must stay out of the banking system,” Reiners said. “Bank regulators are right to use all their tools to make sure they understand how crypto firms are already moving around the edges of the banking sector.”
Fleeting opportunity? Some regulatory officials and cryptocurrency skeptics inside banks said they believe officials have only a short time to put some guardrails on an industry that is gaining more political power by the day.
“We’ve got 12 months, I would guess,” said one banking industry source. “After that, the crypto industry will have so many allies in Congress it will be hard to push back.”
Some leading Republican lawmakers have become vocal supporters of cryptocurrency, warning that too much regulation could push technological innovation abroad.
Representative Patrick McHenry (R-NC), the top Republican on the House Financial Services Committee, has sponsored legislation that would shield some cryptocurrency developers from certain Securities and Exchange Commission (SEC) disclosure rules. McHenry has said his plan will create a “novel regulatory sandbox” for some crypto innovators.
Senator Cynthia Lummis (R-WY), a staunch Bitcoin-booster, has asked the Fed to allow two crypto firms in Wyoming to access the central bank’s payments system. The Fed has so far balked. Last month, Lummis wrote a Wall Street Journal opinion piece voicing doubts about whether Chairman Jay Powell should continue to lead the Fed given the central bank’s “lack of responsiveness” to her request.
For crypto skeptics such as Reiners, the Fed has a monumental decision on its hands.
“If crypto can access the traditional banking system through the Fed, I don’t see how you can ever rinse crypto out of the banking system,” he said.
Regulatory review. A Treasury Department study published last month concluded that “there are key gaps in prudential authority over stablecoins used for payments purposes.”
Fed officials within the Division of Reserve Operations and Payment Systems are reviewing such gaps and what powers the central bank could bring to bear, sources said. At the OCC, staff within the Payments System Policy Group are asking the same questions. Both of those offices have expertise in the blockchain distributed ledger technology that underpins crypto transactions.
The Fed and the OCC declined comment for this article.
Regulators have determined that they do have some powers to scrutinize the development of crypto and stablecoin, said the sources.
The Bank Service Company Act (BSCA) makes bank service providers subject to scrutiny “as if such services were being performed by the depository institution itself.”
Tech companies have come under scrutiny from bank regulators in the past. In 2013, banking software provider Jack Henry & Associates (JKHY) was jointly fined by the Fed, the OCC and the FDIC for having weak disaster-recovery plans that jeopardized the banks that the firm served. Regulators took action after Hurricane Sandy damaged a Jack Henry processing center in 2012.
Two years ago, Fed officials visited a site where the cloud-computing service of Amazon (AMZN) came under scrutiny after a former employee was allegedly involved in a data hack of Capital One bank. Fed examiners “were greeted warily” and given only limited access, according to the Wall Street Journal. A trial against the ex-employee is pending.
‘Untested’ powers. Crypto companies might similarly push back if bank regulators were to show up for an examination, one bank regulator said.
“Our powers are untested,” the official said. “We don’t know yet how this would play out.”
Cryptocurrency has been widely faulted for becoming a tool used by perpetrators who break the law through illicit transactions and ransomware attacks. That could expose crypto companies to regulators responsible for enforcing the U.S. Bank Secrecy Act and Anti-Money Laundering Act (AML).
“If a company touches crypto and also partners with a bank, there are lots of AML questions that can be asked,” said one former regulator.
Bank regulators are developing their enforcement strategy in private but other rules in the works could expand the shared powers of regulators to police banks and their nonbank partners.
The plans would give the Fed, the OCC and the FDIC equal authority to examine banks’ vendors, third-party contractors and partners. Bank regulators are still finalizing the Guidance on Third-Party Relationships.