US crackdown aims to push crypto industry back to the fringes of finance

The regulators are effectively building a wall between crypto trading and the banking and securities markets to prevent the types of systemic vulnerabilities that led to the 2008 financial crisis

Crypto’s free pass is getting yanked as the most powerful US financial regulators rapidly close key doors to the country’s banking system.
 

The increasingly aggressive posture, which has taken shape through public and private actions in the weeks since the collapse of crypto exchange FTX, could push the industry to the fringes of finance. It means new ventures may be smothered before they get off the ground, and banks and digital-asset companies are likely to scrap existing ones and upend business models.

“The regulators are effectively building a wall between crypto trading and the banking and the securities markets to prevent the types of systemic vulnerabilities that led to the 2008 financial crisis,” said Todd Baker, senior fellow at Columbia University’s Richman Center for Business, Law & Public Policy. 

US officials say they’re working together on crypto and deny that there’s some broad effort to crush it. They say responsible innovation that plays by the rules is fully supported. 

At the same time, FTX’s sudden failure forced authorities to act on concerns that the next crypto disaster could be far more severe if digital-asset firms managed to grow large enough to affect the financial system.  

Interviews with more than a dozen current and former regulators, industry executives and lobbyists paint a picture of a deepening crackdown that has the sector on its back feet. Many requested anonymity to discuss the situation candidly.   

Joint Warning
 

Banks are getting the message that they should back away from many crypto endeavors.

Three top financial regulators kicked off the new year with a joint warning about banks’ crypto activities. The Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. on Jan. 3 issued a blunt declaration that said crypto-related risks that can’t be controlled shouldn’t be allowed to migrate to the banking system. 

The action has since picked up. 

Fed officials quickly started flagging the Jan. 3 statement to the banks they oversee. They also privately reminded lenders of their legal obligations when working with crypto clients, especially those that aren’t registered with US authorities, according to two people with knowledge of the ongoing conversations. 

The regulator also released a policy statement on Jan. 27 as it turned down a bid by crypto firm Custodia Bank Inc. to get coveted access to the central bank’s payment system. Officials are working on additional guidance.

The Fed, FDIC and OCC declined to comment.

“Regulators understand they can’t fully de-platform crypto, but they can certainly try to wall it off and minimize any risks,” said Nic Carter, general partner at Castle Island Ventures. “I’ve talked to banking executives and crypto CEOs and they are telling me there’s a highly coordinated move underway to try to ring-fence crypto to cut it off from traditional finance,” said Carter, who called the moves “Operation Choke Point 2.0” in a recent essay.

Fear over the escalating clampdown has contributed to a selloff in crypto, with Bitcoin declining for two consecutive weeks, eating into its gains at the start of 2023.

Binance
 

The world’s biggest exchange, Binance Holdings Ltd., is feeling the squeeze. 

New Binance USD stablecoins will no longer be minted, Paxos Trust Co., the firm that had been issuing the tokens, said Monday. Stablecoins are used as key on- and off-ramps between crypto and traditional currencies.

The New York Department of Financial Services said that Paxos had “several unresolved issues” in overseeing its relationship with Binance. A separate coin issued by Binance itself — known as BNB — tumbled on the news. 

Changpeng Zhao, CEO and founder of Binance, on Monday said on Twitter that if Binance’s stablecoin is ruled as a security by courts, it will have “profound impacts” on how the crypto industry develops in such jurisdictions, and Binance will make adjustments accordingly.

Separately, Binance, which accounted for 55% of the world’s spot crypto trading in January according to CryptoCompare data, is suddenly having trouble getting a US bank to help with dollar transfers for customers. 

The firm said last week that it was suspending deposits and withdrawals of US dollars using bank accounts for all clients. The move was a result of Signature Bank, which had long done business with Binance, pulling back, according to a person familiar with the matter. 

Binance is looking for options, but so far hasn’t secured a way to restart the feature, which is mostly used by institutional trading firms outside the US. Binance.US, the platform that caters to American customers, hasn’t been affected. The firm said putting pressure on third-parties that service the industry instead of working through typical legislative avenues has “shifted the burden directly onto users.”

Signature Bank declined to comment on its relationship with Binance and whether any changes resulted from pressure by regulators. The lender, which has a large unrelated mortgage lending business, has previously said that it’s reducing deposits from digital-asset customers. 

Another lender, Metropolitan Bank Holding Corp., said it would stop working with crypto firms altogether. Crypto.com, a major exchange that has used the bank, said it’s working to shift its business elsewhere, but hasn’t said where. Crypto.com said customers won’t be affected by this transition.

Unfair Standard?
 

In the aftermath of FTX, officials have repeated warnings about stablecoins and general risks posed by cryptocurrencies. 

Michael Barr, the Fed’s vice chair for supervision, urged Congress to step in over the tokens, which he calls “private money.” Fed Governor Christopher Waller said last week that banks have an extra duty to meet know-your-customer and anti-money laundering requirements if they dabble in the sector. He added that crypto was “nothing more than a speculative asset.”

The pressure has resulted in complaints from crypto that the industry is being held to a different — and unfair — standard. 

“Banking services should be available to crypto firms no more or no less than other industries,” said Paul Grewal, chief legal officer at Coinbase Global Inc., which runs the biggest US exchange.

Grewal added that Coinbase meets bank standards on know-your-customer and anti-money laundering rules. 

The tougher stance from regulators is trickling down to projects by banks that seek to use crypto’s underlying technology. One blockchain executive at a bank said that there has been a slowdown even for projects that use distributed ledger technology.

Gensler’s Stand
 

Coinbase is among the crypto exchanges locked in an increasingly high-stakes clash with the SEC over the agency’s jurisdiction.

SEC Chair Gary Gensler and his enforcement director, Gurbir Grewal, have stepped up their focus on the platforms. Gensler contends the platforms are rife with conflicts of interest and openly offer digital tokens that are really just unregistered securities.

Though cases take months or years to build, a flurry of enforcement actions to start 2023 has rattled many in the industry. Wall Street’s main regulator has already brought cases involving four major crypto firms, Genesis Global Capital, Gemini Trust Co., Nexo Capital Inc. and the exchange known as Kraken. 

The SEC’s case against Kraken may have widespread implications for the industry in the US. The settlement resulted in a $30 million penalty and the firm agreeing to halt a program that let American clients generate yields in return for allowing their tokens to be used to facilitate transactions on a blockchain.

Coinbase and Binance are other firms that offer similar programs, which are commonly known as staking.

After the settlement, Coinbase said its staking services are not securities and that it will continue to offer them. Binance.US said it’s “closely monitoring the regulatory environment and will continue to adhere to the rules governing our business.”

The SEC declined to comment, but Gensler did say on Bloomberg Television on Feb. 10, that firms that don’t comply with its rules should expect to face more enforcement actions.

“Many people in the industry see that the SEC is circling the wagons,” said Aaron Kaplan, co-chief executive officer of Prometheum Inc., which runs the trading platform Prometheum ATS. “The major players have to embrace regulation or die.”