The U.S. Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) issued a joint statement on January 3rd to warn banks about the risks associated with cryptocurrencies.
The statement noted that crypto price volatility last year has exposed the vulnerabilities of the sector. Therefore, the regulator has highlighted some key risks that banks should be aware of when dealing with crypto.
The authorities noted that the risk of fraud and fraud among cryptocurrency companies could affect banks that do business with such companies. Additionally, FTX’s recent bankruptcy and fraud allegations against its founder Sam Bankman-Fried (SBF) may have motivated regulators to warn banks against such risks.
The statement said banks also need to be aware of the risks arising from legal uncertainties regarding crypto custody services, redemptions and ownership.
Regulators have warned that cryptocurrency firms may provide banks with fraudulent disclosures and representations. This may include federal deposit insurance misrepresentations and other “unfair, deceptive, or abusive” practices that may harm consumers.
The regulator referred to misleading statements about the FDIC’s scope of coverage for former cryptocurrency exchange Voyager Digital.As a result, on July 28, 2022, the FDIC will warned Voyager Digital will no longer misrepresent FDIC insurance coverage of user funds.
At the time of filing for bankruptcy, Voyager feel safe Users can recover US dollars that Voyager has deposited with the FDIC Insurance’s Metropolitan Commercial Bank. However, the bank later clarified that user deposits were insured by her FDIC, but this insurance would not protect customers if Voyager went bankrupt.
In a joint statement, the regulators cited as a risk for banks the high volatility in the cryptocurrency market, which could affect the deposit flows of cryptocurrency companies. Additionally, the statement warned that banks holding reserves in stablecoins could face significant deposit outflows in the event of a bank crackdown on stablecoins.
Additionally, federal regulators have warned against contagion risks in the crypto sector. The contagion risk arises from the fact that cryptocurrency companies are interconnected “through opaque lending, investment, financing, servicing and operational arrangements,” the regulator said.
The domino effect observed after the failure of Terra Luna, which led to a string of bankruptcies starting with hedge fund Three Arrows Capital, has proven that cryptocurrency companies are intricately connected. This was highlighted again after the collapse of FTX and Alameda Research. After that, Genesis and its parent company, Digital Currency Group, were in trouble.
According to the regulator, this interconnectivity poses “concentration risk” to banks exposed to cryptocurrencies.
Furthermore, the statement noted that the crypto sector’s risk management and governance practices are in their infancy and lack “maturity and robustness.” Moreover, decentralized networks lack governance mechanisms, oversight systems, and contracts and standards that establish roles, responsibilities, and responsibilities.
Furthermore, decentralized systems are vulnerable to hacking, cyberattacks, outages, and the risk of fraudulent finance, officials warned, adding:
“It is important that risks associated with the crypto sector that cannot be mitigated or controlled do not migrate into the banking system.”
The federal agency further said it is evaluating proposals from banks that engage in crypto-related activities. The agency added:
“Given the significant risks highlighted by the recent failures of several large crypto-asset firms, the authorities should exercise caution and caution in relation to current or proposed crypto-related activities and exposures at each banking organisation. We continue to take a cautious approach.”
However, the statement clarifies that banks are “neither prohibited nor encouraged” from providing services to certain types of businesses, including crypto-related businesses.
Federal agencies continue to assess whether or how banks can conduct crypto-related activities. According to the statement, their primary concern is that such activities adequately address “safety and integrity, consumer protection, legal admissibility and compliance with applicable laws and regulations.” . This includes banks that adhere to money laundering, illicit finance, and consumer protection laws while engaging in crypto-related activities.
The agency further stated:
“…the institution believes that issuing or holding major cryptoassets that are issued, stored, or transferred in an open, public decentralized network or similar system is highly likely to be inconsistent with safe and sound banking practices. I think it is very expensive.”