Leading US bank regulators – the Federal Deposit Insurance Corp, Federal Reserve and the Office of the Comptroller of the Currency – have for some time now been attempting to coordinate policies for how and under what circumstances banks can deal in crypto assets. This effort has been called the crypto sprint.
It is turning into more of a half marathon.
On October 27, Jelena McWilliams, chair of the FDIC, confirmed that a series of policy statements in the months ahead will provide guidance on what types of activities are permissible for banks and on associated supervisory expectations.
Prohibiting banks from engaging in crypto will simply see it flourish entirely outside the regulated financial system, so supervisors are inclined to allow it.
McWilliams focused on stablecoins, whose use has grown dramatically as more investors shift between cryptocurrencies and fiat currencies. Regulators want to treat them like deposits.
If stablecoins were to become a dominant form of payment, that could lead to substantial sums flowing out of insured banks, with deleterious impacts on their funding, financial stability and credit creation for the real economy.
Warnings
McWilliams picks up the handiest stick and waves it. Regulators should have oversight of the reserves that stablecoin issuers claim back them one-to-one, as well as the authority to ensure those funds are really there, especially for issuers so large that a run could lead to financial instability.
The IMF also warned about this recently, as did the Bank of England.
But there’s an even bigger and trickier issue. Now that the SEC has allowed the first exchange-traded fund tracking bitcoin futures, what are the rules – around capital requirements, mark-to-market and liquidity – going to be for banks to buy, sell and position on balance sheet bitcoin and other cryptocurrencies?
Now that the SEC has allowed the first ETF tracking bitcoin futures, what are the rules going to be for banks to buy, sell and position on balance sheet bitcoin and other cryptocurrencies?
Banks won’t hold the line much longer at just clearing and settling exchange-traded products if they see customers abandoning them.
With inflation rising and bitcoin subject to a hard cap on supply of 21 million coins, money-printing central banks might reflect that here is a problem of their own creation. How do they fit something so entirely outside a conventional financial system now addicted to endless money creation into that system’s rules?
Risks
There are reputation and trust issues aplenty for bank boards to grapple with. Cryptos are speculative investments with zero intrinsic value and, outside of DeFi, no cashflows to discount. Nothing underpins their price besides faith that someone else will pay a high value for them.
The ProShares bitcoin strategy ETF, which does not invest directly in bitcoin, now lets investors take exposure to the leading crypto with a hefty dollop of added basis risk between the spot price and futures.
Customers want cryptos – and not just retail customers.
Capital Group recently debated bitcoin, while noting that it is not yet an eligible product for any of its funds. Portfolio manager Mark Casey made a strong case that it will be an excellent hedge against inflation while the roughly $100 trillion held in fiat cash and equivalents out of $600 trillion in global financial wealth is losing its purchasing power.
Bank directors can make a judgement on their potential downside if banks put customers into assets that collapse in value.
But bank regulators must soon build a framework for assessing the risks to bank capital from holding cryptos on balance sheet to facilitate customer flows.
In the excitement about the first bitcoin-linked ETFs, the price of bitcoin, which stood at $43,600 on October 1, spiked up to $66,700 on October 20 before falling to $58,500 on October 28.
Risk manage that.
