On January 3, a joint statement was issued by the Federal Reserve, the FDIC and the OCC warning financial institutions of the risks of crypto-assets. The alert is timely given the many notable failures of crypto companies in 2022. Some prime examples are:
- FTX. This Bahamas-based exchange started the year with a $32 billion valuation, paid for Super Bowl ads, and put its name on the NBA’s Miami Heat’s home arena. In November, FTX went bankrupt. Among other alleged problems, FTX is said to have commingled customer deposits with FTX’s affiliated trading firm, Alameda Research, and suffered customer withdrawals of about $6 billion in 72 hours. Notably, the new CEO brought in to oversee FTX’s bankruptcy said he has never before seen “such a complete failure of corporate controls.” This, from the man tasked with cleaning up Enron’s debts after it’s early-2000s accounting fraud scandal.
- BlockFi. This crypto lender filed bankruptcy shortly after FTX collapsed. It had several ties to FTX, including reliance on a $400 million FTX credit facility to stay afloat after other crypto lenders went bankrupt as a result of market turbulence.
- Three Arrows Capital (3AC). This Singapore-based crypto hedge fund began bankruptcy proceedings in June 2022 after the collapse of cryptocurrencies Luna and Terra USD. Liquidation professionals say the 3AC’s founders fled overseas and are not cooperating with efforts to recover assets for creditors.
These stories underscore the caution urged by federal regulators. Significant volatility and vulnerabilities continue in the crypto-asset sector. Some key risks illustrated by FTX and others include: fraud and scams; legal uncertainty regarding custody and ownership rights; inaccurate or misleading representations and disclosures by companies; significant market volatility; stablecoin risk; interconnectedness among certain participants leading to contagion; uncertain or non-existent risk management and governance practices; and heightened risk of open, public, or decentralized networks, such as lack of governance mechanisms for oversight of the systems, absence of contracts to clearly establish rights and liabilities, and vulnerability to cyber-attacks and outages.
Federal regulators stressed that the risks inherent in the crypto-asset sector which cannot be mitigated or controlled must not be allowed to migrate to the banking system. While banks are “neither prohibited nor discouraged from providing banking services to customers of any specific class or type, as permitted by law or regulation,” regulators stress the importance of a case-by-case analysis. Overall, they say:
“Based on the agencies’ current understanding and experience to date, the agencies 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 system is highly likely to be inconsistent with safe and sound banking practices. Further, the agencies have significant safety and soundness concerns with business models that are concentrated in crypto-asset-related activities or have concentrated exposures to the crypto-asset sector.”
Banks should expect federal and state regulators to engage in robust supervisory discussions regarding proposed and existing crypto-asset-related activities.