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On January 27, the Federal Reserve Board issued guidance with important implications for US banks regarding crypto-asset activities.
In a policy statement, the Fed indicated that it intends to use its authority to limit the activities of the member state banks (SMBs) it supervises. Specifically, the Fed intends to:
- ban SMEs from holding cryptocurrencies as principal, which national banks are also not allowed to do; and
- require that SMEs intending to issue US dollar-backed stablecoins (a) demonstrate that they have sufficient controls in place to mitigate the associated risks and (b) receive a no-objection supervisory response before proceeding with the issuance.
This approach is not surprising. As we previously noted in Elliptic, following the collapse of the FTX exchange late last year, banking supervisors are increasingly focused on ensuring that risks and volatility in crypto markets do not spread to the rest of the financial sector.
On January 3, the Fed, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) issued guidance to national banks, emphasizing that they must identify and mitigate their exposure to cryptocurrency-related risk. This reflects the Biden administration’s position that touchpoints between crypto and the banking sector should be limited until further legal and regulatory safeguards are in place.
In light of this increasing scrutiny, financial institutions must ensure they understand any cryptocurrency-related risk exposure they face – whether direct or indirect.
Importantly, the Fed’s statement should not be seen as a reason to turn a blind eye to the risks associated with cryptocurrencies. In the past, banks have sometimes engaged in risk mitigation in sectors and business segments where regulators perceive significant risks. Paradoxically, this in turn can make it harder to detect those risks where they manifest.
For example, when U.S. banks have engaged in de-risking correspondent bank relationships that are perceived to be high-risk—particularly in regions such as the Caribbean and Africa—the consequence is that these risk-free banks often take steps to access clearing in U.S. dollars. facilities secretly. This creates additional challenges for US banks in uncovering risks among their transactions and in identifying potentially hidden or nested activities with those banks that have reduced risk.
A similar dynamic could play out among cryptocurrency activities. If banks avoid direct interaction with cryptocurrencies or with crypto exchanges, these risks could still manifest in more subtle forms that leave banks exposed.
For example, crypto exchanges – particularly those located in or serving high-risk jurisdictions such as Russia – may seek access to US dollar clearing services through nested relationships, using legal names or other identifying details that do not provide a clear indication of their true line of business. .
US banks that process wire transfers on behalf of those high-risk crypto businesses would still face exposure to financial crime and other risks if they fail to detect the activity. Similarly, bad actors can create a series of interconnected shell holding companies with fake NAICS codes and other misleading identifiers to obscure the nature of their cryptocurrency-related business activities.
Accordingly, as supervisors strengthen their scrutiny of banks’ exposure to cryptocurrencies, banks must increase their ability to detect nested cryptocurrency-related risks among their transactions.
One approach that certain financial institutions have taken is to use cryptocurrency-specific name screening tools to identify cryptoasset service providers that can operate within their fiat-based transactions.
Our Discovery product uses Elliptic’s best-in-class data to enable your bank to understand which crypto companies may be active in your financial institution’s transactions and help you understand the associated on- and off-chain risks. By integrating data from Discovery into your transaction monitoring and control systems, your bank can proactively identify exposure to crypto services and implement appropriate risk mitigation measures.
Contact us to learn more about how Elliptic can help your financial institution detect and manage cryptocurrency-related risks across your partners and transactions.
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