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US banking regulators started 2023 with a stern warning to banks to tread carefully when it comes to cryptocurrencies.
On January 3, US Federal Banking Supervisors issued a “Joint Statement on Crypto-Asset Risks for Banking Organizations”. The announcement – issued by the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) – warns banks of the need to ensure that risks from the crypto sector do not spill over into the banking world.
The statement appears to have been prompted, at least in part, by a series of crypto market crises that occurred during 2022.
While the guidance does not mention by name FTX, Terra/UST or any other cryptocrisis in the past year, it states that: “Events in the past year have been marked by significant volatility and exposure of vulnerabilities in the crypto sector. These events highlight a number of key risks associated with cryptoassets and participants in the cryptoasset sector that banking organizations should be aware of.”
The statement further identifies a range of risks – such as fraud, financial crime, cyber security, startup risk, legal uncertainty and others – that banks may face where they offer crypto-asset services or through exposure to crypto-asset business.
It explains that banks are not prohibited from engaging in activities related to crypto or with the crypto sector. However, it added: “It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate into the banking system.” The statement also points out that banks must be able to demonstrate that they are mitigating the risks of any crypto-related activity. which they undertake before doing so.
The joint statement is just the latest in a series of measures by regulators and global watchdogs to ensure that banks’ exposure to cryptocurrencies is manageable. In December, the Basel Committee on Banking Supervision issued guidelines clarifying prudential standards for banks holding cryptoassets.
That same month, the New York Department of Financial Services (NYDFS) released guidance similar to the Joint Statement, reminding banks in New York that they must obtain regulatory approval before undertaking cryptocurrency-related activities. In late 2021, the OCC also told banks that they must obtain approval before engaging in services such as custodial cryptocurrencies or issuing stablecoins.
To date, regulators have largely considered risks in the crypto sector unlikely to have a broad systemic impact on the banking sector or broader financial market stability. However, some regulators fear that over time, the risks of the crypto market spillover into the banking sector could become an increasingly significant problem.
As if confirming regulators’ warnings about the risks of uncontrolled cryptocurrency exposure, on January 5, Silvergate Bank of California announced that it had written off an $8 billion loss as a result of its exposure to FTX. The announcement was followed by a drop in the stock price and layoffs of around 40% of staff.
Regulatory oversight of banks’ exposure to cryptocurrencies will only become more stringent as events like this unfold, something we predicted late last year in our Regulatory Outlook report. It is essential that banks are able to demonstrate to their supervisors that they are able to identify and manage cryptocurrency-related risk exposure – including the indirect exposure they may face through transactions involving crypto-asset business.
To this end, banks should ensure that their compliance teams are trained to identify cryptocurrency-related risks. Elliptic’s educational offerings within our Elliptic LEARN program have enabled compliance teams at some of the world’s largest banks to upskill on cryptoassets.
In addition, banks can use solutions such as Elliptic Discovery, a dataset of thousands of cryptoasset exchanges that financial institutions can use to identify potential exposure to cryptoasset-related risks.
ECB member calls for comprehensive crypto regulation
One of Europe’s top central banking officials has called for aggressive and comprehensive oversight of the crypto sector. In a January 5th blog post, Fabio Panetta – a member of the Executive Board of the European Central Bank (ECB) – pushed back against those who suggest the crypto industry should be subject to minimal or light touch regulation.
Warning that risks such as investor harm and financial crime constitute “a cost to society of an unregulated crypto industry […] too high to ignore,” Panetta argues that: “We need to build guardrails that address regulatory loopholes and arbitrage.” He points to the EU’s Markets in Crypto Assets (MiCA) regulation – due to be finalized early this year and implemented by 2024 – as an example of comprehensive crypto regulation that can help bring stability to crypto markets, although he argued that regulation needs to go even beyond MiCA to address the risks associated with decentralized finance (DeFi) and unhosted wallets.
For Elliptic’s previous analysis of MiCA and regulatory developments in Europe, see here and here.
NYDFS issues its largest cryptocurrency fine to date
On January 4, regulators in New York issued their biggest cryptocurrency crackdown to date. According to an announcement by the NYDFS, crypto exchange Coinbase has agreed to pay a $50 million settlement and invest another $50 million in compliance upgrades, related to deficiencies in its compliance program. The settlement indicates that during investigations conducted in 2018 and 2019, the NYDFS identified deficiencies in Coinbase’s compliance program, including a significant backlog of transaction monitoring alerts and customer files that required enhanced due diligence.
The NYDFS indicates that a significant factor was the growth rate of the exchange’s user base, which caused transaction volume to greatly outpace the growth of compliance controls – a challenge that nearly all crypto and fintech companies face, and which highlights the importance of scalable compliance. .
Further analysis from the Elliptic team on the implications of this alignment is available here.
Iran to return seized mining equipment
Iranian government authorities have been ordered by a court to return equipment to the country’s bitcoin miners – the latest twist in the ongoing saga of Iran’s mining activities.
Iran has operated a bitcoin mining licensing regime since 2018, authorizing miners to exploit the country’s vast energy resources. The licensing regime has been controversial, with some major licenses going to Chinese companies, leading some local Iranian miners to accuse the government of opportunism and favoritism.
Unlicensed local miners continued to mine Bitcoin without approval, putting pressure on the country’s power grid. As a result, the government has called for a moratorium on mining and confiscation of equipment from unlicensed miners, which a court ruling last week said should be returned.
Elliptic’s research found that Iran accounts for about 4.5% of bitcoin mining activity globally – a level of production that could generate as much as $1 billion in revenue annually. Iran’s government publicly stated that the country paid for imports in bitcoins for the first time last year – news that raised concerns about the possibility of cryptocurrencies being used to evade sanctions.
For further analysis of the sanctions evasion activities Iran and other sanctioned countries employ in their use of cryptocurrencies and compliance solutions to mitigate the risks, read Elliptic’s Cryptocurrency Sanctions Compliance Report.
Morocco steps up regulatory efforts for cryptocurrencies
Financial sector watchdogs in Morocco are reportedly making progress in efforts to provide the North African country with a legal framework for cryptocurrencies. Morocco’s central bank Bank Al-Maghrib has finalized a draft law that will regulate the country’s crypto markets, providing consumer protection and other safeguards.
While the exact timing of the legislation is still uncertain – a public-private consultation process is ongoing – the move will mark a major step forward for Morocco, which has until now banned cryptocurrency trading in the country. The move towards regulation – rather than ban – shows recognition that cryptocurrencies are here to stay.
In our Regulatory Outlook Report, we predicted that more countries in Africa will begin to introduce regulation, potentially looking to examples in Europe as models for regulating the sector.
Israeli regulators propose cryptocurrency updates
In more news from the MENA region, the Israel Securities Authority (ISA) has proposed bringing cryptoassets under existing legal frameworks for the financial services sector to strengthen investor protection. The proposals are subject to public consultation until mid-February and are expected to be adopted six months after the proposals are finalized following the consultation.
Singapore’s crypto industry rejects proposed lending ban
The crypto industry in Singapore has come out against a proposal to ban consumers from trading facilities with crypto bullion. In a consultation launched in October 2022, the Monetary Authority of Singapore (MAS) – the central bank and primary regulator for crypto service providers – proposed that regulated crypto businesses should not be allowed to make loans to consumers to facilitate trading in crypto assets or allow them to for buying cryptocurrencies on credit.
The proposed measure is designed to protect consumers from potentially significant losses that may result from leveraged trading. The Blockchain Association of Singapore – a local industry trade body – gave feedback to MAS that the measures could have the opposite effect by prompting consumers to seek leveraged trading facilities on unregulated crypto exchanges abroad, which would only increase risks for consumers. Instead, the Association recommends that MAS focus on regulating activities within Singapore with safeguards, as well as educating consumers about the risks.
To learn more about Singapore’s cryptocurrency regulatory framework, read Elliptic’s country guide to Singapore.
Compliance with Financial Services Regulations
