Federal Banking Regulators Issue Joint Statement on Crypto-Asset Risks to Banking Organizations | Allen & Overy LLP

Federal Banking Regulators Issue Joint Statement on Crypto-Asset Risks to Banking Organizations | Allen & Overy LLP

On January 3, 2023, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency (together, the “federal banking regulators”) issued a joint statement highlighting key risks for banking organizations associated with crypto-assets1 and the crypto-asset sector (the “Joint Statement”). The Joint Statement represents the first joint pronouncement by the federal banking regulators with respect to crypto-assets since the “crypto-asset roadmap” released in November 2021, and its issuance on the first business day of the new year underscores the scrutiny of crypto-asset related activities that banking organizations can expect from the federal banking regulators in light of recent market events.

The federal banking regulators acknowledge in the Joint Statement that banking organizations are neither prohibited nor discouraged from providing legally permissible banking services to customers of any specific class or type. Nevertheless, given the significant risks highlighted by market events over the past year, including failures of several significant crypto-asset companies, the regulators note that they continue to take a careful and cautious approach to current and proposed crypto-asset activities and exposures at each banking organization engaged in or contemplating such activities. Notably, the Joint Statement provides that, based on their current understanding and experience to date, the federal banking regulators believe that issuing or holding as principal crypto assets that are issued, stored or transferred on an open, public and/or decentralized network or similar system2 is highly likely to be inconsistent with safe and sound banking practices. Moreover, the federal banking regulators emphasize that they have significant concerns with the business models of banking organizations that are concentrated on crypto-asset-related activities or have concentrated exposures to the crypto-asset sector.

The Joint Statement includes a detailed list of key risks associated with crypto-asset markets of which banking organizations should be aware:

  • Risk of fraud and scams among crypto-asset sector participants;
  • Legal uncertainties related to custody practices, redemptions and ownership rights, some of which are currently the subject of legal processes and proceedings;
  • Inaccurate or misleading representations and disclosures by crypto-asset companies, including misrepresentations regarding federal deposit insurance, and other practices that may be unfair, deceptive or abusive, contributing to significant harm to retail and institutional investors, customers, and counterparties;
  • Significant volatility in crypto-asset markets, the effects of which include potential impacts on deposit flows associated with crypto-asset companies;
  • Susceptibility of stablecoins to run risk, creating potential deposit outflows for banking organizations that hold stablecoin reserves;
  • Contagion risk within the crypto-asset sector resulting from interconnections among certain crypto-asset participants (including through opaque lending, investing, funding, service and operational arrangements), which may also present concentration risks for banking organizations with exposures to the crypto-asset sector;
  • Risk management and governance practices in the crypto-asset sector exhibiting a lack of maturity and robustness; and
  • Heightened risks associated with open, public and/or decentralized networks or similar systems, including, but not limited to, the lack of governance mechanisms establishing oversight of the system; the absence of contracts or standards to clearly establish roles, responsibilities and liabilities; and vulnerabilities related to cyber-attacks, outages, lost or trapped assets and illicit finance.

Noting the importance of ensuring that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system, the federal banking regulators specifically warn that they will closely monitor crypto-asset-related activities and exposures of banking organizations and encourage robust supervisory discussions regarding proposed and existing crypto-asset-related activities.

Footnotes

1. The term “crypto-asset” is used broadly to refer to “any digital asset implemented using cryptographic techniques.”

2. Crypto-assets issued on such networks would include, for example, Bitcoin and Ether. The Joint Statement does not specifically reference private networks of the kind developed by certain intermediaries for the tokenization of traditional funds or securities.

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