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The failure of three US banks within days has raised questions about how the crypto industry will continue to secure much-needed banking relationships.
On March 8, Silvergate Bank of California announced its voluntary liquidation, indicating that it could no longer continue operations amid significant losses, which were initially triggered by the FTX stock market crash last November.
Silvergate was a major banking partner to the crypto industry, with crypto client business accounting for approximately 90% of its banking activities. Silvergate operated the Silvergate Exchange Network (SEN), a facility designed to provide crypto exchange bank clients with 24/7 access to USD and EUR facilities.
The news of Silvergate’s failure did not come as much of a surprise, given that concerns about its future had been growing, but concerns about the implications of its collapse were heightened by news of instability at Silicon Valley Bank (SVB), whose share price plummeted in late last week.
SVB – which is a banking partner to many startups and venture capital (VC) funds – became the subject of a bank run when depositors began withdrawing funds. The bank, for its part, became overexposed to long-term bonds, whose values fell as interest rates rose, leaving the bank unable to cover deposits as demanded by its customers.
Concerns about SVB’s impending collapse have created widespread concern that startups and VCs could be left without access to their funds. Major stablecoin markets were hit by shockwaves amid news that Circle, the issuer of the USDC stablecoin, was holding some of its dollar reserves in the SVB, causing USDC to shrink from its $1 value. This resulted in the de-pegging of some other stablecoins, with fears that the contagion could continue to spread through the crypto ecosystem.
However, on March 12, the US Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) issued a joint statement indicating that the FDIC will fully protect all SVB depositors without using taxpayer funds.
Officials in the UK, meanwhile, announced similar plans to protect British technology companies with deposits at SVB’s UK subsidiary, which has now been taken over by HSBC as part of a bailout. In Canada, the regulator of financial institutions has announced plans to take control of SVB’s Canadian branch in order to wind up its operations.
The news of bank failures, however, did not stop. In a joint statement, US banking supervisors said the New York Department of Financial Services (NYDFS) had seized Signature Bank to protect depositors. Signature Bank, like Silvergate, has established relationships with cryptocurrency companies across the US and is considered one of the most crypto-friendly financial institutions.
Circle also held part of its USDC dollar reserves there. After the Silvergate failure, Signature’s stock price was under stress, and NYDFS’s proactive intervention was designed to reassure markets that its depositors would not be left out of pocket amid another potential bank run.
These aggressive moves by US banking supervisors to intervene in the banking system are intended to prevent further contagion and to protect the financial system from further instability. At the same time, the Federal Reserve announced that, in an effort to avoid further bank runs, it would extend funding to financial institutions in the US to ensure they have enough liquidity to cover the needs of their depositors. Circle quickly reassured the market that its USDC reserves were safe, and the peg to the US dollar was restored.
The instability among these US banks is not caused by cryptocurrency. Rather, the failures at the three banks were the result of poor risk management that left them vulnerable in the face of rising interest rates. Still, the collapse of banks that were among the relatively small number proactively servicing the crypto sector inevitably raised questions about how the crypto industry would maintain much-needed access to banking services.
Even before the collapse of Silvergate Bank, US regulators had already begun to focus increasing attention on the risks that exposure to crypto and crypto-related entities could have for banks. Although regulators have made it clear that banks are not prohibited from doing business with crypto firms, it was only in late February that the FDIC and other US regulators warned banks to be wary of the prudential risks they could face from exposure to the sector.
As the dust settles from the flurry of activity that calmed the crypto markets, there will inevitably continue to be significant focus on how crypto firms interact with the banking sector. One open question is whether banks with more sound risk management practices might see the loss of these banks as an opportunity to provide banking services to the crypto sector. Circle, for its part, indicated Monday that it has established ties with Cross River Bank and plans to expand its ties with BNY Mellon.
At Elliptic, we will continue to monitor these developments and provide further updates as they arise. As always, we remain of the view that banks can safely bank crypto-asset businesses using sensible risk management approaches, and indeed, that de-risking the crypto sector exacerbates risks by concentrating risks while hindering innovation.
UK continues to crack down on unregistered crypto ATMs
The UK’s Financial Conduct Authority (FCA) has taken a second crackdown on Bitcoin ATMs that have not registered with the UK regulator. On March 8, the FCA announced that it had inspected several locations in East London suspected of having unregistered crypto kiosks.
This is the second such action taken by the FCA in the past month. The regulator announced on February 14 that it had inspected several sites in Leeds in the north of England. In March 2022, the FCA admitted that it had warned all Bitcoin ATM operators in the UK that they were operating illegally, as it had not approved the registration of any crypto kiosk operator under the UK’s AML/CFT regime for cryptocurrencies.
As we noted in a separate analysis, Elliptic has worked with compliant Bitcoin ATMs in the US and elsewhere to enable them to meet AML/CFT requirements, including through our work with the Cryptocurrency Compliance Cooperative. However, FCA actions targeting unregistered operators serve as a reminder that certain risks remain in parts of the crypto kiosk sector.
Iran is making progress in CBDC research
Last week we wrote about accelerated efforts by governments in the US, UK and Australia to explore the potential development of central bank digital currencies (CBDC). While these major economies are considering whether and how to develop CBDCs to keep their financial sectors competitive and resilient, another country is also exploring CBDC development, but with different implications.
On March 6, reports emerged that the Central Bank of Iran had completed a CBDC pilot. Although still only in the experimental phase, the digital trial project involved the participation of Iranian banks – such as Bank Mellat, Bank Tejerat and Bank Melli – sanctioned by the US Treasury Department.
Not surprisingly, some analysts see Iran’s CBDC experiments as a potential measure to lift sanctions. There have also been recent reports suggesting that Iran and Russia may be exploring the development of a gold-backed stablecoin to circumvent the financial constraints both countries face, with Elliptic research previously showing that Iran is generating revenue from Bitcoin mining to cash in. its natural resources in the face. of the US oil embargo. So, if Iran were to launch a CBDC aimed at circumventing financial and economic sanctions, it would hardly be a surprise.
Utah gives legal status to DAOs
Utah has become the last US state to recognize Decentralized Autonomous Organizations (DAOs) under corporate registration laws and grant DAOs limited liability. Utah’s DAO law made it the second state to establish a DAO framework aimed at ensuring that innovators can operate with legal protection.
Wyoming passed a similar law in 2021, making it the first US state to give legal status to DAOs. Lawmakers in New Hampshire are also considering a bill that would provide a legal framework for DAO incorporation. In Elliptic’s 2023 Regulatory Outlook Report, we predicted that this year will see increasing regulatory scrutiny of activities involving DAOs, and these recent efforts by state-level lawmakers to clarify the legal status of DAOs are designed to pave the way for project innovators. which include DAOs to operate legally.
New York AG Targets KuCoin, Considers Ether Value
In another US state, officials have taken action that the crypto industry will likely find far less friendly than Utah. On March 9, New York Attorney General (AG) Letitia James announced that her office filed a lawsuit against crypto exchange KuCoin for operating an unlicensed crypto exchange and making unauthorized offers to New York residents of crypto assets that are securities and commodities.
The AG alleges that KuCoin allowed users in New York to trade certain cryptoassets – such as the TerraUSD stablecoin – without registering with the US Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC), and that it also offered loan program – KuCoin Earn – without registration as a security with the state.
Most notably, the AG alleges that KuCoin’s offering of the crypto-asset Ether (ETH) constituted an offering of an unregistered security. The AG’s claim that ETH constitutes a security because it is a speculative asset comes amid a debate among federal regulators about whether ETH is in fact a security. The AG’s lawsuit requires KuCoin to implement geoblocking so that its services can no longer be accessed from New York. In September 2020, Elliptic wrote about the $280 million KuCoin hack by cybercriminals.
German regulators still do not see NFTs as securities
In Germany, regulators are less crazy when it comes to declaring crypto-asset securities. In an article published on March 8, German regulator BaFin discussed the potential classification of non-fungible tokens (NFTs). According to BaFin, the regulatory status of an NFT must be determined by its specific use and functions.
Any given NFT may be a security, investment, debit instrument or other type of financial product – but this can only be determined by looking at the facts and circumstances of each case. Although BaFin offers its opinion that to date it has not identified any NFTs that appear to be securities, it cannot rule out that at some stage there may be NFTs that meet the classification of securities. The article goes on to state that NFTs can pose a risk of fraud and money laundering.
To learn more about Germany’s approach to cryptoasset regulation, see our country guide to Germany.
Biden Administration Proposes 30% Bitcoin Mining Tax
As part of its fiscal 2024 budget, US President Joe Biden’s administration is proposing a large tax on bitcoin mining. The Biden administration reportedly plans to impose a 30% tax on proof-of-work mining activity in an effort to target the energy-intensive mining industry.
Biden’s budget also seeks to eliminate an exemption in the tax code that allows cryptocurrency traders to sell their assets at a loss, deduct the loss on their taxes, and then immediately buy back the same assets. By closing the so-called “wash sale rule”, cryptocurrencies will be put on an equal footing with stocks and other securities, where traders cannot buy back assets they sold at a loss for 30 days.
This is not the first set of contentious crypto-tax provisions under the Biden administration, which in late 2021 inserted provisions into a spending bill requiring crypto-trading entities to disclose information about their users for tax reporting purposes.
Compliance with Financial Services Regulations
