The signs of the death of crypto banking are everywhere. The two biggest crypto banks, Silvergate Capital and Signature Bank, have been shut down by regulators. New York Community Bank's Flagstar unit, which bought some of Signature's assets, did not acquire any digital asset banking or crypto-related assets or deposits.
"We were doing quite a lot of work last year with banks that were interested in this and we're doing much less this year," said Adam Shapiro, partner at Klaros Group.
Cryptocurrency exchanges, investors, venture capitalists and some Republicans have all protested that it's not right to choke off an industry that is not illegal.
Barney Frank, who was chairman of the House Financial Services Committee from 2007 to 2011 and a co-sponsor of the Dodd–Frank Act, has said he suspects the New York State Department of Financial Services shut down Signature Bank simply because it had crypto companies as clients. He served on the board of Signature, which had $89.59 billion of assets in December.
"Somebody ought to look and see, I wonder, are we the first bank to be closed, totally, without being insolvent?" he said in an
New York regulators have denied that it took over the bank to send an anti-crypto message.
"The decisions made over the weekend were not crypto-related," an NYDFS spokesperson said in a statement on Tuesday. "DFS has been facilitating well regulated crypto activities for several years, and is a national model for regulating the space."
Rep. Tom Emmer, R-Minn., wrote in a March 15 letter to FDIC Chairman Martin Gruenberg that federal financial regulators have "weaponized their authorities over the last several months to purge legal digital asset entities and opportunities from the United States."
During the recent closure of digital asset and tech centered banks like Silvergate, Signature Bank and Silicon Valley Bank, he said, individuals from across the industry, including Frank, have said regulators have been singling out financial institutions to "send a message to get people away from crypto."
"If this is the case, these actions to weaponize recent instability in the banking sector, catalyzed by catastrophic government spending and unprecedented interest rate hikes, are deeply inappropriate and could lead to further financial instability, Emmer said.
Emmer cited several recent instances in which regulators have discouraged banks from doing anything crypto related, including a January 3 statement by the FDIC, Federal Reserve and Office of the Comptroller of the Currency.
"The Administration's demonstrated effort to choke off digital assets from the United States financial system is a lazy and destructive regulatory strategy that is stagnating innovation and subjecting American users of digital assets to less sophisticated regulatory jurisdictions," Emmer wrote.
Before the collapse of FTX last October, this argument could have gotten traction, according to Jim Angel, associate professor of the Georgetown University business school's Psaros Center for Financial Markets and Policy.
But at this point, "regulators will say, look, we're being thorough and careful and we're protecting U.S. investors from the next FTX out there," Angel said. "And they've got a point that a lot of these crypto operations don't exactly have a compliance culture at their heart. A lot of them are people coming from the 'break things and ask for forgiveness later' culture."
Another Operation Choke Point?
Operation Choke Point was an initiative the Department of Justice began in 2013 that investigated U.S. banks' business with firearm dealers, payday lenders and other companies believed to be at a high risk for fraud and money laundering.
Crypto businesses and their venture capital funders
"This sure smells like Operation Choke Point," Angel said. "It's the same kind of thing in that, whether it's conscious or not, at this point [regulators] will look for any excuse to shut down banks that are providing aid and comfort to crypto."
Some of the reason for this, he theorizes, is that bitcoin and many other cryptocurrencies function as replacements for the U.S. dollar.
"The U.S. dollar is one of the primary exports of the United States of America," Angel said. "It is a well-respected store of value, used the world over, and we're very proud of the fact we've never canceled our currencies. Doing things that help people to compete with the dollar are not in the best interest of the U.S. government."
The recent anti-crypto messaging from regulators feels sudden, given that Silvergate Capital had been serving crypto exchanges and crypto institutional investors since 2012, with the full knowledge of its regulators, including the Federal Reserve.
"Over the course of the last several years, there has been a debate among the policymakers about how to deal with crypto," said Michael Held, partner at WilmerHale and former general counsel at the Federal Reserve Bank of New York. "One view was that it's better to bring crypto within the regulatory perimeter and prevent the growth of another version of shadow banking. Another view was that it was better to keep it outside the perimeter because it might introduce new and novel risks into traditional finance that, at least right now, were not fully understood."
Beginning this year, regulators have coalesced around a view that traditional finance needs to very carefully manage its risks in this space.
"A lot of people have read between the lines and taken the message that at least right now, they should not be doing any business with crypto," Held said.
Held expects regulators to come out with clear guidance for banks in this area.
To be sure, Silicon Valley Bank, Silvergate and Signature all had difficulties that had nothing to do with crypto. All three had interest rate and balance sheet risk. As interest rates rose, their assets fell in value and their depositors withdrew money. All three had a run on the bank, something no financial institution can withstand.
Just a temporary hold?
Some observers see the government's tough-on-crypto stance as temporary.
"I don't think over the long term [crypto banking] is dead at all," said Held. "Banks in traditional finance as well as those focused in crypto know that this technology is not going away. In order for the U.S. banks and industry to maintain competitiveness over the long term, they need to be well positioned to compete in this space. I don't think we've seen anything from the regulators to say traditional banks are legally prohibited from partnering with or banking crypto firms."
Any bank that has anything to do with crypto also needs robust, rigorous risk management programs, Held said.
"What crypto firms should be focused on right now is building those really robust risk management practices so that when the time is right from a regulatory perspective, from an economic perspective and from a technology perspective, they will be well positioned to take advantage of opportunities over the long term," Held said.
Banks also have to be concerned about concentration risk, he said.
"The idea of crypto banks, banks that are just focused on crypto, is something that the regulators are, at least right now, not entirely comfortable with," Held said. "Banks that do want to at some point get involved in crypto, need to think about diversified business models to mitigate the risk business models."
It's possible that a bank could play the payment settlement role Silvergate and Signature were filling with their Silvergate Exchange Network and Signet networks, respectively, Shapiro said.
But with the risk exposure that bank would have to take on, and the headaches of explaining it to regulators, "it's not clear that anyone would, and it's certainly unlikely in the current environment that regulators are going to give a signal that they are keen to keep this activity onshore and within sight," Shapiro said.
"Banks are going to read the tea leaves, read what does appear to be some quite visceral dislike of the sector from senior regulators," he said.
Impact on crypto companies
Large companies like Coinbase should be OK because they have enough business and can pay enough that it's worth a bank taking on the hassle, Shapiro reasoned.
Many early stage crypto startups, however, have reported that they cannot get bank accounts.
This is partly because such companies aren't profitable yet, Shapiro explained.
"If you are going to go through all the hassle and diligence of banking that sort of client, you are relying on them growing enough where they can pay you significantly more than any sort of monthly minimum that tends to get charged on this sort of account," he said. "As the regulatory environment gets colder and chillier, the costs of taking that risk go up. You are going to need VC-like upside in terms of the growth of the business to make it worth your while."
All of this means it's unlikely crypto innovation will happen in the United States for some time.
"The world needs a reset for the potential of the technology," Shapiro said. "And a reset involves people that have interesting ideas being able to get access to the banking system, to pursue the kinds of use cases that may actually add some value to society and not just redistribute wealth to winners and losers. It's going to be hard to do that onshore. We may see more early stage innovation abroad just because it's going to be easier to support. If I wanted to try and work on an early stage crypto company in the developed world economy, I'd be shooting right back to London now."
