Tom Curry

Recent national and international developments have once again highlighted the risks and rewards inherent to financial technologies. And, as we wrote in our March 14 Nutter Notes column, regulators are taking notice of developments in the cryptocurrency space.  

High-profile cryptocurrencies continue to stay in the news. In recent months, Bitcoin has risen to, and retreated from, record highs and cryptocurrencies overall have grown to nearly $1.5 trillion dollars in market value as of May 2021. Their surge in popularity and growing acceptance among average investors, asset managers, traditional financial firms and high-profile names in technology and business has caught the attention of central banks and regulators.  

Volatility, Illicit Finance Feared 

After reaching record highs in April 2021, Bitcoin’s value plummeted shortly thereafter when the Chinese government announced increased use restrictions, which includes the outright ban on financial institutions’ provision of crypto-related services. The Chinese government took their opposition to cryptocurrency a step further on June 21 by banning Chinese banks from supporting cryptocurrency transactions, citing security concerns stemming from the anonymous nature of blockchain trading. Banks have been advised to investigate and identify parties involved in blockchain trading networks, and subsequently freeze accounts linked to cryptocurrency trading. 

Kate Henry

The Chinese government is not the only authority taking a tougher stance on cryptocurrencies.  

Iran was forced to suspend cryptocurrency-related activities immediately on May 26 after the large amount of energy used to mine cryptocurrency caused country-wide blackouts.  

Also, the Basel Committee on Banking Supervision announced on June 10 that it plans to require banks with exposure to volatile cryptocurrencies, such as Bitcoin and Ethereum, to hold an amount of capital equal to its cryptocurrency asset exposure. A 1:1 regulatory capital charge makes cryptocurrencies less attractive to banks. Although the Basel Committee indicated that banks’ exposure to cryptocurrency assets at the present time is limited, these requirements indicate that it recognizes the inherent risks associated with cryptocurrency and are eager to take steps to mitigate those risks before they materialize into a systemic safety and soundness issue.  

U.S. market regulators have remained relatively cautious of cryptocurrency, making clear the risks that accompany the advantages of the technology.  

Since taking office, Treasury Secretary Janet Yellen has repeatedly cautioned the public as to the ease with which cryptocurrency can be used for illicit finance. Gary Gensler, chair of the Securities and Exchange Commission, has further stated that there are “gaps” in the current regulatory structure. And Michael Hsu, the acting comptroller of the currency, has stated that cryptocurrency – like all new banking practices – has the potential to result in increased, unregulated shadow banking if not adequately regulated. 

Armand J. Santaniello

Regulators Could Help Crypto Growth 

While domestic regulators are acutely aware of the clear and present risks to cryptocurrency, all signs indicate a growing regulatory approach that safely and thoughtfully facilitates the growth, not the hindrance, of other forms of cryptocurrency.  

The Office of the Comptroller of the Currency issued an interpretive letter Jan. 4 reiterating long-standing precedent that the business of banking should evolve and adapt to technological changes as they occur and discussed permissible crypto-related activities for national banks and federal savings associations.  

Despite this precedent, the OCC interpretive letter and other crypto-friendly OCC actions are under review by Acting Comptroller Hsu, who has recently stressed the need for closer coordination amongst leading financial regulatory agencies such as the Federal Reserve and the Federal Deposit Insurance Corp., partly to address regulatory jurisdiction issues and to facilitate coordinated efforts moving forward under the assumption that the cryptocurrency market will only grow larger. 

FedNow a Better Option? 

Two potential alternatives to the more volatile cryptocurrencies include stablecoins and central bank digital currency (CBDC).  

A stablecoin is a cryptocurrency that is tied to another asset such as a national – or “fiat” – currency, or a commodity such as gold, and this link aids to maintain a fixed value. While stablecoins may be tied to fiat currency, they do not have legal tender status or deposit insurance.  

CBDCs, on the other hand, are fiat currency in digital form, are overseen by the same national monetary authorities who oversee traditional fiat currency, and recently gained the endorsement of the Bank for International Settlements. As Federal Reserve Governor Lael Brainard noted in a May 24 speech, although cryptocurrency “may have the potential to improve efficiencies, increase competition, and lower costs, digital assets pose heightened risks” and that CBDCs may be a safer alternative that “enhance operations . . . in response to demands from . . . clients for services such as custody of digital assets.”   

Governor Brainard also acknowledged CBDCs’ shortcomings and suggested that the FedNow Service, an instant payments infrastructure being developed by the Federal Reserve, would be a better solution. FedNow would be open to banks of all sizes and would offer the advantages of 24/7/365 service. Consumers and businesses would be able to send and receive payments digitally through a mobile device and recipients would enjoy immediate access to funds.  

As we stated previously, U.S. financial regulators understand that the pace at which financial technologies are developing makes it difficult to ensure safe consumer use and engagement. Despite these difficulties, U.S. regulators’ ultimate goal is not to stifle innovation but rather to create proper oversight that increases trust in the market amongst market participants. 

Thomas J. Curry is a partner in Nutter’s corporate and transactions department. Kate Henry and Armand J. Santaniello are associates in Nutter’s corporate and transactions department. Curry is former U.S. comptroller of the currency and all are members of the firm’s banking and financial services group.