Transcript:
SCHOENBERGER: Cryptocurrencies were everywhere last year. Taxi drivers and construction workers talked about them. Billboards went up in cities like Nashville and Miami. But then the crypto exchange FTX exploded spectacularly.
I'm Chana Schoenberger, Editor-in-Chief of American Banker. Welcome to BankShot. Ebrima Sanneh, one of our Washington reporters, covers the FDIC and OCC. He wanted to find out what the demise of FTX would mean for the crypto sector, which has been teetering on the edge of regulation for years.
HSU 2: [2:27]
I have long been a crypto skeptic. The crypto industry remains immature and rife with risks despite several years in the mainstream spotlight, billions of dollars of venture capital investment and millions of hours of code commits. In 2022, losses from fraud exceeded a billion dollars. Losses from scams exceeded two and a half billion dollars and losses from hacks exceeded $3.8 billion. One of the largest stablecoins imploded and multiple crypto platforms failed due to outright fraud, poor risk management or both. [3:00]
SANNEH: That was Acting Comptroller of the Currency Michael Hsu giving a speech at the American Bankers Association's Risk and Compliance Conference in June.
Banks were already highly cautious about crypto in the wake of FTX's collapse late last year. And to make matters worse, a string of crypto bank failures this year has left the crypto sector with even fewer willing banking partners to launch and sustain business. I wondered to what extent the industry feels these effects post-FTX.
From American Banker, I'm Ebrima Sanneh, and this is Bankshot, a podcast about banks, finance and the world we live in.
JACOB: [14:50] I think there were a lot of important bankruptcies leading up to FTX. But the FTX collapse itself only made things more difficult for the industry, provoked some other company bankruptcies or collapses. And of course, the criminal investigation is still ongoing. I think there will be more people charged. So in some ways, it's not confined to what happened in November. It's again very much still a thing. And I think as we see more being unfurled in the bankruptcy case, in the criminal investigations, we find out more what kind of deals FTX was making — what happened — that might still have some more fallout. [15:32]
SANNEH: That's Jacob Silverman, a freelance journalist with years of experience covering the crypto industry, and something of a crypto industry whisperer. He even co-authored the book "Crypto Scam" with actor and crypto skeptic Ben McKenzie, who you may know for his role in the Fox TV show "The O.C." Silverman says that despite FTX's collapse disrupting the crypto sector and causing conflicts among major players, the industry hasn't completely disappeared as some predicted. Sam Bankman-Fried, the former CEO of FTX, currently faces charges related to financial crimes brought forth by the Securities and Exchange Commission, led by its chairman, Gary Gensler.
JACOB: [15:59] There's still been a lot of instability in the market, despite the sort of rally — moderate rally, I'd say — this year. And I think there's more a sense of weariness among a lot of these companies. [16:11] [17:54] I think after the FTX collapse, there's an understandable sort of jockeying for position. There was a lot of blame that was going around. I mean, some people said, "Hey, Sam was just a lone, bad apple, or or rare, bad apple." Some people said, "Oh, this is Gary Gentsler's fault for pushing companies like FTX offshore." [18:12]
SANNEH: Silverman suggests that although the cryptosphere's instability intensified during the crypto winter, the uncertainty is increasingly self-perpetuated and internal. The crypto industry's existential crisis has brought to light preexisting fault lines that had been simmering beneath the surface for some time.
JACOB: [16:20] For example, DCG, which is an important crypto conglomerate, and Gemini, run by the Winklevoss twins — they're basically at war with each other both on Twitter and in the courts. And a lot that really only came to light after FTX went down and I think it did change the environment both kind of rhetorically or politically for the industry, but also, of course, on the level of the balance sheet. So now you have the Winklevoss twins accusing DCG of fraud and suing them in court but making an accusation of fraud on Twitter. Those kinds of things weren't really happening as much before. I mean, in crypto, you see everything but in terms of a sense that there's more open conflict in crypto. I think that that's definitely something that's increased since the fall of FTX. [17:07]
SANNEH: He says the crypto industry is still firmly in the midst of the crypto winter, a period characterized by market instability and financial uncertainty.
JACOB: [18:51]
So that's still going on. I mean, some companies don't have the money they claim they have and some do have something still in the tank to survive this crypto winter, perhaps, however long it might be. And then there was also a recent moderate rally and assets so I think some companies feel like there's still life yet in consumer crypto in the U.S. But that kind of varying perspective, such as it is, I think, didn't really exist in crypto before this fall. There was more alignment, I'd say, in the industry. And now there's a little bit of introspection, and a lot of open disagreement about, you know, how to salvage this thing and how to move forward and kind of who belongs at the table. [19:32]
SANNEH: So the crypto industry is in disarray: infighting, and seemingly an erosion of the comradery I had assumed held the movement together.
I wanted to talk to someone who could speak to the industry side of things, so I called Jaret Seiberg of TD Cowen, an expert in crypto who advises financial institutions based on government policy outlooks.
SEIBERG [2:34]
I'm a policy analyst. I look at what we should expect from the government as it relates to the oversight of the crypto space. [2:44]
SEIBERG [3:08]
I go back to financial policy with my first job out of college in 1990-91 following the last of the laws of the savings and loan crisis. And so I started following crypto back when … oh, probably six or seven years ago when initial coin offerings began to really proliferate and uh, that has just dragged me into what's a really fascinating space, but one where there's still a tremendous amount of change that is gonna occur. [3:47]
SANNEH: Having followed crypto as long as he has, Seiberg has seen trends in the industry come and go. Years later, and more than six months after FTX, I hoped he could provide some context for just how exceptional the moment we are living through is, and now, with the benefit of hindsight, what lessons have been learned.
SEIBERG [9:50]
What the FTX collapse did was free the regulators to get more aggressive. That's resulting in more enforcement actions and much more litigation. That litigation is going to start resulting in court cases, and those court decisions are going to compel Congress to act. And so I view FTX as being that snowball at the very top of the mountain. And as it has rolled down the hill, it's picked up more snow and it's gotten bigger and bigger and bigger and, you know, pretty soon.…[10:29]
SEIBERG [10:34] q
We're gonna get that, you know, big explosion when the snowball hits the bottom of the mountain, and you know, that's, that's gonna give us rules. And I think that's exactly what the space needs. We need to know what works, what doesn't. We need to know how to protect consumers, how to protect investors. And at the same time, crypto needs to demonstrate that it's actually of economic value and it's not just speculative. And I think all of that is going to happen in the next three or four years. [11:10]
SANNEH: It's going to take time, but we'll get there, the next few years will be a wild ride, but ultimately provide some certainty — sort of what the industry has called for all along. As these court battles unfold, we might start to see some order in this chaotic space.
SEIBERG [14:30]
We still have several years to go to get through all this policy chaos. I mean, then the court decision we're all waiting for involves Ripple, that case has been pending for several years. That may offer us some clarity from a judge about when tokens become securities, but it's not going to be definitive. It's going to get appealed, one way or another, and it's only going to be one circuit weighing it. That's why I think the, you know, potential for litigation against and by Coinbase is going to get so much attention because, again, you need to get cases in front of judges for the law to be developed. And you know, too many crypto companies settle cases rather than fight. And the more these companies fight, the more we're gonna get judges clarifying how the law works and as those judges weigh in, it will narrow the scope of what Congress needs to do in legislation to regulate the space. [15:45]
SANNEH: Each legal battle matters because as of yet, the crypto industry and the regulators are talking past each other. The industry thinks crypto should be regulated within its own unique and novel framework, while the SEC believes cryptos are — already regulated — securities. The precedents set by each legal ruling will arbitrate between these two positions, and gradually reveal a more detailed sketch of a regulatory framework. Like most policy debates, the result will probably land somewhere in the middle.
Seiberg notes something I want listeners to earmark for later — the fact that too many companies settle rather than fight. To hash out precedents, companies will need to stick their neck out and fight the SEC, even if it means short-term pain.
SEIBERG [16:15]
I think this period right now is extraordinarily challenging for the companies, because it's very costly to change how you're doing business, and you have to give up a lot of the synergies that have been central to some of these platforms, right. I mean, we've heard SEC Chairman Gary Gensler talk about how custody needs to be separate from trading, you know, he's gone after staking operations. All of this goes to sort of the heart of how crypto has developed, which is as a supermarket approach, right. So these platforms sort of provide all of your crypto needs. And I think what the government is saying is that's not how it works anywhere else in financials, and that's not how we want it to work for crypto. And that's why we see all these cases and, you know, we need judges to tell us that the SEC is right, and then we need Congress to weigh in and whether they're comfortable with that outcome. [17:32]
SANNEH: Unlike traditional financial institutions, crypto firms have developed a sort of one-stop-shop model, where various functions of finance — like custody and trading — are conducted under one virtual roof. The Feds do not like this, and discussions of siloing various aspects of crypto will be a major point of discussion over the next few years. I asked Seiberg to lay out some of the constituent departments within the crypto supermarket.
SEIBERG [18:21]
Typically, custody is separate from trading. That's how it is in the securities world. You know, another issue is staking services. There's a lot of uncertainties there, including whether it's a, you know, unregistered investment product, or is it a service, who actually controls and owns tokens that are pledged. So that's another business that is under scrutiny. You have, you know, market-making activities, you typically don't see those on an exchange and then you have the exchange business, the actual trading. You see a lot of work with stablecoins as well, and how those operate, you know, these are all distinct businesses, and I think the question the SEC is raising is that there can be conflicts of interests and all of this, and, you know, if you are, if you are custodying on a platform that's offering multiple services, then you are at risk, if any one of those services causes the platform to fail. And that's not how things normally work in financials. [19:55]
SEIBERG [26:26]
That's why we're having so many congressional hearings. That's why the SEC has gotten so much more aggressive on the enforcement front. Nobody wants to have another FTX on their watch. [26:42]
SANNEH: OK, so clearly, the government is turning the screws on crypto, but that's not entirely new, and the SEC was zeroing in on exchanges even before the crypto winter. So what makes the post-FTX moment such a bellwether event for the industry? According to the experts: the scale of the scandal.
Lawmakers often don't act until they are forced to. The fact that Sam Bankman-Fried personally cozied up to so many shakers in D.C. despite being an alleged fraudster was likely a wake-up call for those in the Beltway — despite its contained fallout, crypto proved its potential to cause real world harm.
SEIBERG [8:49]
I think the FTX collapse was the defining moment for crypto. It represented the end of the era of the U.S. government being mostly hands off, and the start of what I think is a multiyear period of just policy chaos. But it's through all that policy chaos that we're going to get a final regulatory regime. And we're going to get a crypto sector that can be permanent and can produce economic benefits for the country. [9:27]
SANNEH: While I was recording this podcast, some more big news broke in the crypto space, a reminder of the real-time legal battles that continue to shake up the cryptocurrency industry. In June, the U.S. Securities and Exchange Commission, the SEC, sued major crypto exchanges Binance and Coinbase. The lawsuits accused both exchanges of violating securities rules, alleging that these exchanges offered cryptocurrencies that the SEC considers to be unregistered securities. It's been quite a squeeze on the valuations of both companies. And here's the kicker—the SEC's actions led to a major classification shift. They've now labeled a whopping 67 cryptocurrencies as securities.
Binance and its CEO, Changpeng Zhao (Chanpen Jow), got hit with a range of charges, from manipulative trading practices to mishandling customers and failures of corporate control. And as if that wasn't enough, Nasdaq-listed exchange Coinbase faces similar, though more targeted, allegations of violating securities laws — minus the fraud. The SEC's actions open up a new front in the legal battle over the future of crypto regulation.
To understand the nuts and bolts of the lawsuits, I had the chance to chat with Art Wilmarth, professor emeritus of law, who's got an impressive background and extensive expertise in financial regulation. He's been teaching various courses at George Washington University's law school for over three decades, from banking law to American constitutional history. With all that knowledge and experience, Professor Wilmarth has become quite the sought-after expert in the field of financial regulation. I feel really lucky to have soaked up his expertise, and I asked him to walk me through the whole situation, starting with the SEC's accusation that crypto exchanges are basically acting as security exchanges.
WILMARTH [4:55]
On these exchanges like Coinbase or Binance, essentially, you know, people are handing over their investment funds, and they're buying these tokens, but they themselves are not involved in any way in how the tokens are managed, and they expect that they're gonna get a return based on what the platform or exchange tells them. That looks to me like a pretty conventional understanding of security. [5:27]
SANNEH: Gary Gensler appears to agree. But what is the reason for SEC's exclusion of the most well known cryptocurrency — Bitcoin? To a lay-person like me, that may seem odd. But Art says that has to do with the fact that the SEC has effectively ceded that certain coins are outside their jurisdiction. And it all has to do with where a commodity ends, and where a security begins.
WILMARTH [5:34]
The CFTC, you know, believes that it has overlapping jurisdiction. And it has certainly inserted some jurisdiction with regard to Bitcoin. It's called some of these tokens "digital commodities." That's sort of an interesting concept to me because, you know, commodities as we normally think of them are assets that have some intrinsic value, right. If you're talking about corn, wheat, pork bellies, you know, minerals, those are assets that have some kind of inherent value. It's not clear to me, you know, exactly what inherent value some of these tokens have now, of course, they have what value people will pay for them. So you can argue that well by, by people paying for them or by mining Bitcoin, you're creating a value but it's interesting that the idea of a digital commodity, I think, is, to me, an underexplored concept. The SEC, I think, is, you know, people criticize the SEC for doing what they call regulation by enforcement, although that's pretty much been part of the SEC's history from the very beginning, rather than rulemaking. But at least, you know, if you read these complaints, they're, they lay out in some considerable detail what their theory is. I am not an expert on the Commodity Exchange Act, but I would like to see more explanation as to what a digital commodity is. And, for example, why Bitcoin is a digital commodity. I think that would be helpful. [7:30]
SANNEH: So he's not entirely sold on the hard lines between digital commodities and securities, but it makes sense that the SEC would target assets that they believe are unquestionably securities. One crucial thing to understand, he says, is that the United States is unique in that it separates commodity and security regulation across two completely separate regulatory bodies.
WILMARTH [7:33]
There's this underlying question as to why the SEC and the CFTC are separate in the first place, right, because securities and commodities are both different types of investments directed at different types of investment communities, but they're clearly investments. And by all, under any sense of logic, it seems to me the SEC CFTC should be one agency, and investments in securities and commodities should be pretty much handled under the same general principles. As you know, there have been periodic efforts to merge the two agencies. There was some serious discussion of that, you know, when Dodd Frank was being considered, and even earlier, but of course, there's this huge political turf battle between the agriculture committees and the finance and banking committees, you know, in the House and Senate that, that the House Agriculture Committee is determined never to lose its jurisdiction over commodities trading and certainly the banking and finance committees are not willing to sort of let their securities jurisdiction disappear. So that's a problem. And that's, to me, kind of a political problem. We have this fragmentation between two agencies that are really doing the same thing; they should be doing the same thing to protect the investment community and assure liquid, transparent, reliable markets for those investments. So I think that if Congress does nothing, I think you're going to see the SEC being increasingly active and aggressive. And I think their view is we're not trying to drive crypto out of existence. We're simply trying to say you need to follow the same rules of the road as any issuer of securities needs to follow. And so Binance, well Binance, but certainly Coinbase if you want to operate as a broker, if you want to operate as an exchange, if you want to operate as a clearing agency for settlement of sales of these crypto securities — which we think they are — then you have to register with us and be regulated with us in the same way that NASDAQ or the New York Stock Exchange, or typical broker-dealers are regulated or clearing agencies. I think you're gonna see obviously more action by the CFTC as well. I think they were, my own view is that they were severely embarrassed by what happened with FTX because they were sort of viewed as allies of FTX in trying to get the Gillibrand-Lummus bill and the Stabenow-Boozman bill, they were widely perceived in the public as allies of FTX. And so when FTX collapsed, I think that tarnished the CFTC's reputation and perception. I think they're trying to regain some of their footing. [10:52]
SANNEH: OK, so back to the SEC's cases this year. I asked Art what he is focusing on as the cases go to trial.
WILMARTH [38:41]
Then the next question becomes, OK, but is the SEC right? You know, are they correct in asserting that existing law already gives the rules of the road and they're simply telling you what the existing law requires. So that's, I think, where the Ripple case becomes important because if the SEC wins that case, people are going to say, well now look, this is another court decision saying the SEC is correct in what they're doing. If the case came out against them, that would obviously then say, well, the SEC doesn't have authority to establish the rules they're establishing. [39:16]
SANNEH: Like Seiberg said, the cases need to be looked at in tandem, they are part of a web of legal battles that each could potentially settle small chunks of regulatory uncertainty. And each one affects the other.
WILMARTH [39:46]
I would be surprised if the SEC loses the Ripple case. But if they do, that would be, you know, a significant development. If they win, I think again, it weakens the argument that we have no rules of the road, or the SEC is inventing rules that don't exist, you know, that they're just making it up. So the more that the SEC succeeds I think that that blunts the argument or weakens the argument that we need completely different rules of the road. [40:22]
WILMARTH [41:16]
So the first argument was you didn't have rules of the road, The SEC is, I think, trying to answer that. Yes, we do. The second question is the SEC doesn't have authority to make the rules or they're making the wrong rules. Well, I think the litigation is going to tell us something about that. Whether how the Ripple case comes out or how the other cases come out, will tell us something about: Is the SEC authorized to be doing what it's doing? Then the third question is: OK even if the SEC is right, and they have authority, I think McHenry and his supporters are arguing: These are the wrong rules, right? We need to change the rules. We need to change the agency and change the rules; we need to give it to the CFTC; we need to give them more industry friendly rules. Right. [42:01]
WILMARTH [42:15]
If the SEC is wrong, then that's going to weaken them, but let's say the courts uphold the SEC. Then you now say OK, we have rules of the road, the courts have upheld them so far. Nobody has proven the SEC is wrong. Now persuade me as to why we need completely different rules for this industry, different from any other types of investment, and why the SEC shouldn't be the main agency to be dealing with this. Why should we give it to the CFTC? That's really the argument McHenry and his group are making but, you know, are you going to persuade a majority of Congress or a majority of the public that this is a good move to make. [42:54]
SANNEH:I wanted to check back in with my friend and journalist Jacob to get his reaction to the Coinbase and Binance suits.
SILVERMAN [0:45]
People knew that there's probably some action coming from the SEC. These investigations have been going on for a long time, and we knew that big companies like Coinbase and Binance were largely cooperating and sending documents participating in depositions, things like that. I think it's a big deal though. Even though you could, you could see this coming. They are talking about both Binance and Coinbase as essentially selling unregistered securities. And, the two cases are different in some ways, but I think they're both existential for the companies and for the industry, and they're certainly being taken or interpreted differently by, let's say, people in the crypto industry versus crypto skeptics or people on Capitol Hill. But I think everyone does seem to agree that, you know, this is a big moment for crypto and will probably determine its future in the U.S. [1:42]
SANNEH: From an initial read of the legal action, it appeared to me that the Binance suit was far more damning, with the SEC throwing the proverbial kitchen sink at the firm. SEC's action against Coinbase is a bit more focused — it centers around the most pivotal legal question for the future of the industry: Are most cryptocurrencies securities? Jacob agreed. While Coinbase faces less flashy charges, the outcome of the case could be monumental, he says.
SILVERMAN [2:28]
I think it could be more influential in some ways in terms of just establishing rules of the road and helping to settle some of these questions around crypto tokens being securities or whether only certain tokens might be. So in that way and sort of the bureaucratic regulatory structural sense, I think it will be pretty important. I agree with you that the difference seems to be with Binance, there is a lot of suspect behavior, frankly, and stuff that may point to illicit or illegal activity. And I think no one will be surprised if there are DOJ charges later on. I mean, there's been reporting indicating that there's a criminal investigation into Binance and CZ himself. And there are important questions there about securities regulations and things like that, but you're right that Coinbase is more narrowly focused on that, but in its own way that could be more consequential for how this industry really establishes or positions itself in the U.S. going forward. [3:27]
JACOB [4:13]
I think the decision to go after Coinbase, which is, in a lot of ways, considered the most regulated and certainly the most well-known publicly traded crypto exchange in the U.S., if not the world. That struck some people as unusual or has produced some outrage in the industry because some people think, well, look, Coinbase has been trying to do things the right way. Coinbase has talked a lot about seeking regulatory clarity — in the industry's favorite phrase — but I think also, undoubtedly, Coinbase, precisely because it occupies that role of being this large, publicly traded, U.S. based exchange. It has to kind of also play this role of being a regulatory target, frankly, or a case for figuring out this stuff. So in that way, to me, it's not necessarily surprising that Coinbase is the one that he goes after. [5:11]
JACOB [7:00]
I think with Binance, even if you're a Binance defender, there's a lot there. Certainly that poll quote that the SEC has been throwing around about, from a Binance executive saying we're operating an "effin" unlicensed securities exchange is a big deal. But so, you know, the Binance one is the big drama, and I think will have a big impact and will be ongoing and could end up turning into a criminal case or just a wide swath of litigation, including the CFTC. But as we discussed, Coinbase is sort of the almost boring one for legal heads, but it will probably be just as impactful going forward. [7:38]
SANNEH: It will be impactful indeed. Remember what Seiberg said about crypto companies not fighting enough? Yeah, well Coinbase, widely considered one of the most visible and reputable crypto exchanges — yeah, they want all the smoke. In a recent interview, Coinbase CEO Brian Armstrong seemed more than willing to go to war with Gary Gensler on behalf of his sector.
What we need in the United States at this point to get regulatory clarity, unblock this issue, get rid of the turf war, is regulatory clarity. And I think what's gonna have to happen now, since the CFTC and the SEC have not been able to sort of, you know, figure this out, is, we're gonna have to have Congress step in and draft legislation that will unblock this issue in the United States, or we're gonna have to have the courts create more case law, which is partly what we can do by going to court with the SEC here, is just helping get case law created. [8:33]
JACOB [5:38]
The SEC's mandate is basically to protect capital markets and consumers. So the hope would be here that whatever legal process or litigation comes out of this, that eventually you land in a spot where there's more regulatory clarity, as industry calls it. I mean, some people might say there's already sufficient regulatory clarity and that's why we're here, but this in the end works out better for consumers who will hopefully be protected and know what they're trading in. But also for an industry that does that, at least part of it wants to have a more stable and certain foundation so that they can build in the U.S. and, you know, in the more optimistic perspective, I think that could happen here. But of course, there's a lot of resistance and there's a lot of outrage on the part of industry that thinks, like, hey, Coinbase and others have been trying to, to take the lead or do the right thing here and they've been sort of rewarded or met with what they call regulation via enforcement, via litigation and actions by the SEC, and not really by gentle instruction, which I think is what they hoped for. [6:47]
SANNEH: OK, so if it wasn't clear already, crypto companies are in a kind of limbo, as of yet without regulatory clarity, but headed in that direction. But where does banks' relationship with crypto go from here? Acting Comptroller Mike Hsu told the press recently that he sees banks' interest in the technology waning for the short term.
HSU 1 [00:00]
You've had a fair amount of turmoil in the crypto space. And aside from Silvergate and some of the contagion from that, it's been — [rapping] knock on wood — the cross contagion to the banking system has been relatively contained, and we think that's a good thing. [0:23]
HSU 1 [0:33]
The FOMO on crypto has gone down this year and I think that's really largely due to the events of last year in 2022, crypto winter was pretty tough for the crypto industry and those who I put into the bucket of crypto curious — on the banking side — lost some of that curiosity, given some of those events. And the issue of scams, fraud, hacks, those continue. Those haven't gotten better over time. That issue has kind of receded in terms of materiality. It's something we care about. It's something that we still expect banks to approach prudently, but I'm just not hearing as much noise or demand for banks to get in on crypto. [1:23]
SANNEH: And it's not just the crypto skeptical regulators who think so, wading into an unregulated space makes less sense if rules could be on their way, says Seiberg.
SEIBERG [31:25]
It's difficult to see why banks want to get out in front of this issue. Given that there's so much policy uncertainty, and so much regulatory scrutiny. I think the banks are likely to take a wait-and-see approach. [31:42]
SANNEH: While banks' rollout of full-fledged crypto enterprises is far away for now, firms are still interested in the advantages of blockchain. Seiberg says while there is still a market for true crypto believers, he thinks what is really catching steam these days is the idea of utilizing crypto's underlying technology for making payments in traditional finance more efficient.
SEIBERG [23:54]
You certainly have true believers out there who see crypto as the future of money and believe that, you know, government issued currencies are going to lose credibility over time, and crypto is the only way to protect your resources. I think that's a shrinking percent of the crypto investor space. And I think most investors today are fascinated by the technology and what it can do. Take, for instance, the trading of equities, right? It is gonna be a massive effort for the industry to get to T plus one settlement for equity trades, you know, a blockchain based system where you tokenize equity trading, you can get to effectively instant settlement of these trades. And that has enormous benefits for systemic stability. You know, you reduce the role or the risk from clearing houses, you know, you're able to just settle transactions immediately. And so it's that ability to have instant settlement that gives the crypto technology such, you know, that's what makes it so interesting. You can get instant settlement.[25:28]
SEIBERG [12:42]
The distributed ledger technology should prove to be extraordinarily useful going forward. That is separate from any particular token or any particular blockchain. And so I think we are in a period where we're trying to understand how the rules are going to work for regulating all of this, and at the same time, I think we're gonna find out, you know, how useful all this technological innovation actually is for consumers, for businesses and for payments globally. Just because the technology is better doesn't mean it's gonna get adopted. Right? Betamax was better than the, you know, typical VCR but the VCR won out. You see plenty of examples where the inferior technology becomes the preferred technology. And I think that's part of the challenge for crypto, it's to figure out how to take this really innovative solution and deploy it. [13:58]
SANNEH: For all the talk of banks, I had yet to speak to the industry directly. So I sat down with Paige Pidano Paridon from the Bank Policy Institute to hear the big bank perspective. She corroborated much of what I had heard already: Banks are interested, but taking baby steps until regulatory clarity comes about.
PAIGE PIDANO PARIDON [10:39]
And I think, though, the fact that banks operate within, you know, a robust regulatory framework is important to keep in mind with these products. And so I think that to the extent that, you know, the, again, the benefits of the technology can be offered within that framework. You know, getting the regulator comfortable with that, I think, ultimately will better serve consumers than using the products outside of the regulatory perimeter. We've seen what the risks are of, you know, this unregulated ecosystem. [11:20]
PAIGE PIDANO PARIDON [4:02]
As was the case during the crypto winter, and why we didn't see a lot of meltdown in the traditional financial sectors, because the linkages between the so-called traditional financial sector and the nonbank crypto ecosystem are relatively limited. And, you know, I think that is still the case. There's not a lot of linkages and relationships between the two at scale. However, in terms of the technology, our BPI members are keen to research and develop the use of the technology to bring the benefits that come with distributed ledger or blockchain based technology that, you know, there seems to be some some level of demand for, to harness that technology within the regulated regulatory perimeter of the banking sector. So, for example, exploration around blockchain based deposits and token based deposits. [5:24]
PAIGE PIDANO PARIDON [18:21]
At the end of the day, it doesn't seem like it was the use of the technology that brought down FTX. Again, if it was just a number of other things, including, you know, fraud, misappropriation of customer funds, etc. [18:43]
PAIGE PIDANO PARIDON [29:22]
Banks want to serve their customers, and client demand and banks want to be our innovators and want to be, you know, are, pro-innovation. And so, you know, I think that we need to make sure that there is an understanding among the regulators and other policymakers that the banks are able to manage the risks. And that, you know, to the extent we want consumers and investors to be able to benefit from technology, you know, there's no better place for for them to access the services and products than in the regulatory, the regulated banking space, one of the most regulated industries in the country [30:03]
SANNEH: So Regulators remain highly skeptical of bank-crypto partnerships — but — in a recent speech, Acting Comptroller Mike Hsu shed light on areas of crypto where regulators see limited potential. It's worth noting that the kinds of use cases regulators are interested in are a far cry from the speculative status quo most think of, but his comments underscore the staying power of blockchain technology, with one caveat: Regulators will not allow public, trustless blockchains. That's because in a public blockchain — the most common in crypto — there is no trusted central intermediary vetting transactions or admitting users, which makes it challenging to enforce regulatory frameworks, combat illicit activities and ensure compliance with laws like anti-money laundering (aka AML) and know-your-customer (aka KYC) requirements. In contrast, permissioned blockchains, operated by trusted entities, require permission to join, provide regulators with more control and the ability to enforce compliance measures, making them a preferred choice in regulated industries.
HSU 2 [3:12]
Public blockchains which support the vast majority of cryptocurrencies circulating today appear to suffer from a key design flaw: trustlessness. The goal of having a trustless or trust-minimized blockchain requires a decentralized consensus mechanism, such as proof of work or proof of stake. These mechanisms are inefficient and create a trilemma between decentralization, security and scale. Achieving all three simultaneously is not possible with a public blockchain. To grow and manage the trilemma requires either Ponzi-prone tokenomics, highly technical workarounds or both. As a result, the crypto industry remains largely self-referential and disconnected from the real world. Moreover, the nonpermissioned nature of public blockchains that make them attractive to criminals and others engaged in illicit finance and full compliance with anti-money laundering rules is extremely difficult for crypto intermediaries to achieve. By contrast, centrally operated, trusted blockchains have the potential to deliver security and achieve scale efficiently; embracing the need to trust a blockchain operator, and forgoing trustlessness eliminates the need for decentralized consensus mechanisms and the associated tokenomics enables the technology to solve settlement problems efficiently and securely at scale without the need for hype. Such trust blockchains are also easily permissioned, making full compliance with AML rules achievable. The greatest promise for blockchain technology today may lie in its potential to improve settlement efficiency through tokenization of real world assets and liabilities on trusted blockchains. [5:03]
SANNEH: Even with FTX in the rear-view-mirror, the crypto industry remains in the midst of turbulent times, navigating without a definitive legal framework to operate within. However, there are intriguing developments on the horizon. The government has adopted a more proactive stance toward enforcement, showing a renewed willingness to engage with the crypto space. Simultaneously, companies are displaying a newfound willingness to fight in court, hoping to shape the regulatory landscape they've yearned for.
While such turbulence may deter banks from taking a more active role, the convergence of these factors could finally provide the much-needed regulatory clarity that has eluded the sector for so long.
SCHOENBERGER: This episode of Bankshot was written and produced by Ebrima Sanneh and edited by John Heltman. Our executive producer is Chana Schoenberger and our sound engineer is Kellie Malone. Special thanks this week to reporter Jacob Silverman, George Washington University law professor Arthur E. Wilmarth, Jaret Seiberg of TD Cowen and Paige Pidano Paridon of the Bank Policy Institute, as well as the Arizent Studio team. If you liked the show, please like and subscribe, or visit www.americanbanker.com/subscribe to get some of the best news and analysis out there. From American Banker, I'm Chana Schoenberger, and thanks for listening.