Following the release of the Policy, the Fed promptly refused to issue a permit for a special-purpose depository institution, stating that: “[t]he firm’s novel business model and proposed focus on crypto-assets presented significant safety and soundness risks.”
This action clearly signals that the Fed will look for an activity that can be conducted safely, soundly, and to be legally permissible. Moreover, the Policy is skeptical that engaging in crypto assets can be done safely and soundly, underlining that they’re done on public, permissionless blockchain networks.
This new regulation ties in nicely with SR Letter 22-6, with which the Fed requires state member banks to give notice to the Fed before engaging in crypto-related activities. With these two requirements, the Fed seems to have placed a firm grasp on crypto activities when it comes to traditional banking and financial institutions. Just one look at the government’s road map that was released on the same day as the Policy can make any crypto enthusiast more skeptical about the future of crypto in banking and financial institutions.
Voting rights in decentralized autonomous organizations (DAO), along with wealth in crypto, tend towards concentration, almost as equally as in traditional finance. Furthermore, the fact that most networks in crypto cannot handle large volumes of transactions, at least not yet, inevitably involves intermediaries to push the process along. While we have seen a growth in the popularity of decentralized exchanges (DEXs), the fact is that centralized exchanges (CEXs) are still critical players in the crypto ecosystem.
The fact that crypto users want to turn away from the lack of trust in institutions is that trust is often replaced by trust in individuals running a protocol or a CEX on a blockchain. While it is hard to argue that individuals are less greedy than institutions, the fact that individuals in the crypto space are less regulated makes the whole exercise riskier for the end users.
Finally, the democratization of the finance aspect of crypto is also hard to swallow, as most lending platforms require significant amounts of collateral before they decide to loan funds to their users. This will most likely exclude the ones that lack financial assets in the first place from enjoying this “democratization.”
The relationship is still evolving
The relationship between crypto and traditional banking and financial institutions is ongoing and ever-changing, with its future still uncertain. While there are those that believe that crypto will completely replace banking, the predominant opinion is that both systems will coexist with each other.
Greater security and privacy are the main selling points of cryptocurrencies compared to traditional banking. Furthermore, blockchain technology ensures that users are in control of their own funds by eliminating intermediaries such as banks when exchanging cryptocurrencies peer-to-peer (P2P). A scenario in which cryptocurrencies continue to grow as a standalone financial system and become a viable alternative to banks and financial institutions cannot be ruled out completely.
If such a scenario occurs, we could see a rise in specialized financial institutions that solely focus on crypto and blockchain, along with any new payment product that comes about as a result of technological advances. In such a world, banks and traditional financial institutions would struggle to survive. However, this scenario is still far in the future. If it ever happens.
At the moment, banks are trying to expand into crypto in order to avoid the scenario described above. This is critical for the end users as banks continue to play an important role in mainstream everyday activities. With the developments brought on by the failure of the FTX exchange and the US government’s tighter regulation, we could say that we’re at a critical point in the industry.
The failure of riskier crypto enterprises has emboldened bank regulators to step up and make their expectations clearer. The bottom line of all the regulatory attempts revolve around the fact that banks are special entities that are inextricably linked to and constrained by the shifting regulatory framework. In other words, banks are highly regulated and supervised entities. They’re key to the current world order, which is why there are high guardrails around the crypto-related activities they can undertake.
You scratch my back, I scratch yours
The plan on which banks and fintech companies cooperate at the moment seems to be the prevailing business model going forward. If the cooperation between a bank and a fintech company is within the above-mentioned guardrails, then both sides can come out ahead.
Fintechs look to utilize the bank’s resources, infrastructure, and compliance to offer digital assets to the masses. On the other hand, the bank leans on the more agile fintech companies for the back-end technology and front-end user experience to support crypto services. Such partnerships with good implementation practices, working under the confines of regulation, can increase safety for the end users when it comes to accessing digital assets.
Another often overlooked aspect of the cooperation between these two financial players is the on and off-ramp services. With this, we mean the ability to buy crypto using fiat money and vice versa. Limiting these services, first and foremost, limits the liquidity of crypto markets. Second, it undermines the trust users have in the entire crypto ecosystem since “cashing out” then becomes too cumbersome, with intermediaries taking a huge cut to offer such services.
Having a unified approach to this aspect could deepen the cooperation of fintech and banks. Needless to say, it would be done for both their own benefit and the benefit of the end users.
Crypto is not going anywhere anytime soon as blockchain continues to present an advanced technology that can be utilized across numerous fields. Perhaps the biggest use case at the moment is the collaboration of traditional financial institutions with their agile fintech counterparts in the field of finance. Of course, the regulators still have a key role to play, hopefully focusing more on how to slowly integrate what blockchain and crypto have to offer and not on putting up barriers to entry.
This romance of banks with fintech must have a common denominator, and that is cryptocurrencies. If the developments keep heading in the right direction, we may see legal risk, uncertainties, and compliance issues slowly fade away from the discussions surrounding crypto. Finally, the implosion of large players and the loss of capital for retail investors has to stop. Hopefully, these new developments will speed this dream along.