What should crypto regulation look like?

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Transcription:

Penny Crosman (00:03):

Welcome to the American Banker Podcast, I'm Penny Crosman. It has become increasingly clear in recent weeks that cryptocurrency companies, and perhaps the banks that work with them, need regulatory rules and supervision. The SEC's findings about Ripples XRP cryptocurrency and the collapse of the cryptocurrency exchange FTX are two cases in point, but far from the only examples that illustrate the need for government involvement. But who should supervise such companies and what kinds of rules should be applied? Today we're with Georgia Quinn, general council of Anchorage Digital, and Rachel Anderika, chief risk officer of Anchorage Digital, who are going to share with us some thoughts on this. Welcome, Georgia and Rachel.

Georgia Quinn (00:48):

Hi there. Thank you so much for having us.

Rachel Anderika (00:50):

Yeah, hi. Hi, Penny. Nice to meet you.

Penny Crosman (00:51):

Thanks for coming. So to my mind, the first question here is, and I'm not sure if you guys have an answer to this, but the first question is, who is best equipped to regulate crypto companies? Some people talk about the SEC, some people talk about the CFTC, some people talk about a new entity or maybe some kind of combination of the SEC and the CFTC. Do you guys have an opinion?

Georgia Quinn (01:18):

Yes, we absolutely do. And I'm going to start with a pretty lawyery thing and say with respect to the requisite regulatory agency, it depends. It will depend on the actual product or service that's being offered. Because in this country, unlike other jurisdictions, say Singapore, where they have a single regulator, all services in our country, depending on the type of product or service offered, you'll be regulated in a different way. And while it does make it a lot more confusing, there is a certain line of thinking that is helpful behind that. So when we think about the product or service known as custody, which is the safekeeping of client assets, the type of regulation needed in that instance is what's called prudential regulation. And that requires the oversight by a regulatory body that manages both the capital requirements of the organization, the control structure of the organization, and has certain supervisory powers that allow them to actually go in and examine the financial service provider.

(02:35)

And so we think that custody type services should be regulated by federal prudential regulators such as the OCC, the Fed, et cetera. And why do we say federal? Well, we say that because crypto knows no borders. And so to try to regulate this asset class on a state by state basis is not only inefficient, but it's ineffectual. So now there are other products and services like exchanges and marketplaces, and those require different type of regulation, a market-based regulation. And the agencies in our country that are instilled with that obligation are the CFTC and the SEC. And when we think about this asset class, we really think that it has more of the hallmarks of a commodity or ultimately forex. And those types of assets have traditionally been regulated by the CFTC, which we think is the appropriate market regulator for this asset class.

(03:35)

And we think it's very important that the CFTC be granted authority to regulate the spot market in this asset class. Now, there are certain assets, digital assets that do have security like characteristics and those such as a tokenized stock issuance or a digital bond, something of that nature. It's obviously a security and that should squarely fall within the ambit of the SEC. But getting back to the initial question, the problem that we're facing right now is no one's laying this out in a cohesive way, and we do not have the regulatory clarity that we need in order to function, which is sending a lot of organizations and institutions offshore where there are less regulations, less consumer protections. And then we get into the trouble what we're facing now. And now I'll hand it over to Rachel to kind of add her two cents.

Rachel Anderika (04:32):

Yeah, I mean, of course I agree Georgia with all of these premises, and one of the things that we've learned, and as Penny, we are the first federally chartered crypto custodian and we fall under the regulatory authority of the OCC. And when Georgia talks about regulatory clarity, there are some pockets of regulatory clarity within this space that are very well laid out within existing banking law. And so when we think about custody regulation, for example and how important that has become in this current environment, our charter comes with regulatory obligations vis-a-vis things like the Bank Secrecy Act, 12 CFR 9 requiring segregation of client assets, information security regulations, et cetera. And they are all examined in the very same way that any financial institution would be examined. And so we think that there's a lot of muscle memory within the federal regulatory umbrella because they do take a principles-based approach, which does allow for some interpretation under existing banking law and supervisory guidance.

Penny Crosman (05:51):

You both have made some great points. So as you were talking, I was thinking, well, Anchorage has a National Bank charter, which means it's regulated by the office of the controller of the currency and also has some supervision from the Fed and the FDIC. Correct?

Georgia Quinn (06:07):

We actually do not because we are not a depository institution.

Penny Crosman (06:11):

Okay, so it's the OCC,

Georgia Quinn (06:14):

Correct.

Penny Crosman (06:14):

Strictly. I was just wondering because some of these companies that are fairly prominent in the space like Paxos and Gemini and Circle have a trust banking license from New York and also a Bitlicense. Does that have any merit or does that need to be replaced with a national regulator as you're saying?

Georgia Quinn (06:36):

Yes. So we went that route. Previously we were a state chartered trust as well. And we just found that it was very inefficient to have to basically passport that state charter to every single state in which we wanted to provide our services. So the way the state regulatory framework operates is every time you want to offer product or service in another state, you have to review those state's regulations and either get reciprocity from that state or try to get some sort of exemption to be able to offer your services or actually get some sort of licensure in that state. And so to have to do that 50 times was really inefficient. And then also not surprisingly, I guess there are certain state regs that actually conflict with one another. And so it's not operationally efficient to have to offer a certain type of product or service in one state that you can't offer to certain residents of another state. And so being able to federally preempt all of those state regs, including the Bitlicense, has been extremely helpful for our operational efficiencies.

Penny Crosman (07:46):

That makes a lot of sense. Rachel, anything to add?

Rachel Anderika (07:49):

Yeah, and I would just add to that, I mean another aspect that was incredibly important to our decision to convert to a national charter because we did a conversion of our South Dakota trust into a national charter was the stance of a national bank as an unequivocal qualified custodian and which was monumentally important to our institutional client base because there is an abundance of regulatory clarity written into the black letter of the law on what counts as a qualified custodian. And it is less clear when it comes to a state trust.

Penny Crosman (08:29):

So you guys talked a lot about cryptocurrency exchanges and about custody as a crypto activity. Another thing that we've been hearing and seeing a lot is activity with stablecoin that are currently issued by these companies with trust bank charters, and that regulators have said should be issued by regulated banks. Do you guys have any thoughts on that idea that only banks should be allowed to issue stablecoin?

Georgia Quinn (09:04):

Sure. So first and foremost, we do not think banks should be issuing stablecoin because banks are not notoriously technology providers. And we think that the most important aspect of the stablecoin is the underlying security infrastructure of the technology. And so we need security and technology experts to be developing those stablecoin. Now, the reserves, which back those stablecoin should 100% be held in a federally chartered bank, and we would not argue with that at all. But we see the actual issuance of stablecoin as a partnership between an entity that has that security and technology expertise to develop the underlying protocol and to store the reserves, which we think should be cash and cash equivalents reserved one for one in a federally chartered institution institution.

Penny Crosman (10:05):

And does a company like Circle fit within that description?

Georgia Quinn (10:09):

Yes.

Penny Crosman (10:09):

Okay.

Georgia Quinn (10:11):

Now they need to hold the, now just to put a finer point, we would prefer the reserves to be held in a federally chartered institution. And there are some transparency elements around that we'd like to see. And we're actually encouraged by some of the draft stablecoin legislation that's being put forward. So Maxine Waters and Patrick McHenry have a draft bill that we're supportive of.

Penny Crosman (10:39):

What are some of the basic elements of that bill?

Georgia Quinn (10:43):

Yeah, so I mean number one, in order to actually be called a stablecoin it has to be backed one for one by cash and cash equivalents, USD fiat reserves. So none of this algorithmic nonsense and the reserves then have to be held within a regulated institution. And there's going to be some back and forth as to whether that should be a state institution or a federal institution. But ultimately even state banks are generally regulated by the Fed. So we'll get that Fed overlay, which is what we think is really important. And otherwise it's pretty simple and I hope we get to talk about these other things, but just some kind of financial services 101 things transparency, no related party transactions without full disclosure, no co-mingling of firm and client assets. Very simple basic principles that are touched upon in that bill. I find it kind of ridiculous that they have to be specific about those things that should just be granted. But yeah, that's all set forth in the bill as well.

Penny Crosman (11:50):

Do you think that if that bill had been passed, the FTX issues might have been caught sooner or not allowed to happen?

Georgia Quinn (12:03):

So probably not. And that's just because that bill is very specific and related to stablecoin because even though FTX did issue its own token it was never billed as a stablecoin. And so that actually wouldn't have had too much effect. But what it might have done is get that flywheel going, which would've opened the doorway for other regulation. And that's kind of what we're hoping the stablecoin bill does because it does have bipartisan support. And it would be nice to just start moving in that direction because then if we could get other regulation in place, kind of what I was alluding to earlier about market regulation with respect to the exchanges and then prudential regulation with respect to the underlying custodian that definitely would've prevented this.

Rachel Anderika (12:55):

Yeah, and just to add on Georgia's point, I mean one of the things that we've talked about and that we've talked about even within the regulatory community is that what would have prevented the FTX is a segregation of custody from exchange assets. And so if you held your assets with Anchorage and we have a custody exchange network that is designed to prevent the very thing that happened at FTX if you had your custody assets held here, you would have access to those custody assets because we are regulated trust and those assets are unequivocally those assets of the client. And so I think that even outside of the stablecoin issue here, I mean we have having very clear standards and operating standards around how custody and exchanges relate within this space would've prevented this. And in fact, in the wake of this, we've seen an unbelievable amount of imbalance with respect to in institutional clients who want to onboard with Anchorage, et cetera. I'm sure that others in this space have seen this as well because exchanges are not appropriate places to hold your funds. I mean, they've been equated to how you use a public bathroom. You want to get in, do your business and get out. You're not going to set up shop in that public bathroom.

Georgia Quinn (14:27):

And Penny, you see this in traditional finance. The New York Stock Exchange is not holding your assets. It is just a marketplace where trades cross. And so the fundamental purpose of an exchange and a custodian are quite different. And frankly, there's often a conflict between those two purposes. And so they need to be separated as they historically have been done in traditional finance.

Penny Crosman (14:56):

That makes a ton of sense. Is there anything else? If you were able to write your own law about cryptocurrency and related activities, is there anything else that would be in your dream law that would cover all of these things and everything else going on in the crypto industry?

Georgia Quinn (15:19):

Oh girl, here we go. You asked for it. But absolutely, because I kind of think about this basically 24/7 and what I'm about to say. I think that what I want you to really remember about what I'm about to say is that none of this is crypto specific. And it's very sad to me. It's very sad that we have to learn these same lessons over and over again. I just marvel at the short memory of the financial services industry, but here we go. So as we noted, separation of exchanges from custody, those should be two separate participants. They should have transparency and visibility into both, but not performed by the same entity. No co-mingling of firm and client assets. It's just a fundamental principle of finance. You do not do it. No related party transactions without full disclosure and consent. So you cannot have related parties transferring client assets among themselves without disclosure to the client. And then four is just fundamental financial controls. And basic financial principles — don't borrow short and lend long. Security interests have dual controls when you move client assets. So a single individual or employee can't move client assets on their own unilaterally. And have periodic audits. You've got to be able to show what is happening on with respect to client assets, with respect to firm assets, and the preparation of financial statements and other auditable materials is essential. Somebody's got to be watching you.

Rachel Anderika (17:11):

And to be clear, the elements that Georgia just laid out are all of the elements of our regulatory framework that exist today and the standards that Anchorage has held to as a federally chartered trust bank. It's not in the same way that it would be in an exchange, but these are all the things that we have to do as a national bank. This is what a custodian has to do in the nationally chartered space. These are principles that exist today in fiat. And as Georgia mentioned, what we're talking about here is not necessarily a failure within crypto, it is a failure of basic banking principles and the principles on which the American financial system has been built.

Penny Crosman (17:58):

My understanding is there are more than a dozen bills in front of Congress right now in this area. Do any of them check these boxes for you?

Georgia Quinn (18:09):

Yes, for the most part. There are a couple with respect to the CFTC being able to regulate the spot market for crypto. And I think that's definitely the right direction. We have some tweaks here and there, but directionally it's right. Like I mentioned the stablecoin bill before, it's definitely where we think things should go. So those are the ones that we're most interested in. There's some other tax treatment and things, which obviously are important, but they're not going to fix these kind of catastrophic situations.

Penny Crosman (18:51):

So you'd probably like to see a new bill that would really encompass all of these principles.

Georgia Quinn (18:58):

I actually, I don't need to throw the baby out with the bathwater. I think that we could tweak what's out there. I mean the Lummis – Gillibrand bill is very comprehensive and I actually think we could take parts of that and just put it together, add a few tweaks, and that would be great. So yeah, I don't think that we need to just start from scratch. A lot of good work has been put into this and I think we take and build, and that's really the way the legislative process generally works, anyway.

Penny Crosman (19:32):

So final question. How has Anchorage Digital been doing throughout this crypto winter and do you think having a bank charter has helped you throughout this tumultuous time?

Rachel Anderika (19:46):

We have performed unbelievably well with the market fallout. I mean, absolutely we have an impact from the fall, just the way our fee structures work in the fall and the pricing crypto, and everybody has some level of sensitivity to that. But when we talk about the level of risk management that we have in place that we are required to have a place as a function of our national charter the business model that we have as being an institutional custodian doesn't lend itself to a great deal exposure to a great deal of volatility in this space. And so that's one piece of it. The second piece of it is that when you're talking about federal regulation, there's a very large flight to quality and so custodying your assets. And so look, there was a lot of fear, uncertainty, and doubt in the market in November, obviously. And there were a lot of institutions that were pulling out their funds into, not from Anchorage, but pulling their funds into self custodys. And now what we're seeing is as everything is clearing, as it is becoming clearer and clearer what the difference is between federal regulation and something that is it that does not exist within in an appropriate regulatory framework, we are seeing those clients responsibly. So kind of bringing assets back into our secure platform under the protection of our licensure.

Penny Crosman (21:22):

All right. Well, Rachel and Georgia, this has been a really interesting discussion and I appreciate your balanced answers to these questions. Thank you so much for joining us and to everyone, thank you so much for listening to the American Banker podcast. This podcast was produced by me with audio production by WenWyst Jeanmary and Kevin Parise. Rate us, review us and subscribe to our content at www.americanbanker.com/subscribe. For American Banker, I'm Penny Crosman. Thanks for joining us.