Coordinated Attack on Crypto-Friendly Banks by US Regulators

A two-pronged attack on crypto and the ecosystem surrounding it: many industry experts and analysts in the crypto space are seeing a pattern in the US authority’s enforcement actions in the recent past.

Do these actions have a larger agenda, more than what meets the eye? Some experts and analysts say yes. What is that agenda? Why does it appear that crypto-friendly banks face a coordinated and well-thought-out attack by the US regulators?

The answer partly lies in the chronological details of the enforcement actions. So let’s begin with that!

A Severe Crackdown on the Crypto Industry: Crypto Regulation US

The year 2023 started with the US Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Controller of the Currency (OCC) issuing a joint statement on crypto-asset risks to banking organizations on January 3rd. Although it did not advocate a ban on banks holding crypto assets or dealing with crypto clients, it discouraged them for the same on a ‘safety and soundness’ basis.

The collective stance of these authorities undoubtedly stemmed from a deep institutional strategy. The strategy became evident when the US SEC head Gary Gensler rearticulated his longstanding take on crypto assets: all crypto tokens except Bitcoin are securities, expressing impatience with the crypto industry for not adhering to SEC regulations.

The next enforcement action came with the US-based exchange Kraken settling with the SEC for a US$30 million fine and deciding to discontinue its staking services for US residents.

Next on the list was Paxos and the stablecoin BUSD. As made public on February 13th, Paxos had received a Well Notice 10 days earlier hinting at the SEC’s plan to sue Paxos over the issuance of Binance’s BUSD stablecoin, citing it as an unregistered security.

Two days after, on February 15th, the SEC introduced a new rule asking crypto exchanges to either become officially licensed custodians or leverage the services of a third party with a custodian license.

Such enforcement actions against crypto businesses continue. As of March 3rd week 2023, Coinbase said that the SEC had informed the company of plans to pursue an enforcement action against the exchange and its staking service.

If frequent such crackdowns, either at a business level or at an industry level, were not enough, the US crypto regulations laid their eyes on the crypto-friendly banking sector.

Crypto-Friendly Banks Fizzling Out

Many are referring to the failure of ‘crypto-friendly’ banks, including Silicon Valley Bank, Silvergate, and Signature, as outcomes of a concerted effort from the authorities. They have named the effort Operation Choke Point 2.0.

The original Choke Point - started in 2013 - was a scheme to marginalize a few legally operating industry segments by pressurizing the banking system that helped those industries to grow.

The same strategies are being played out for the crypto industry through Operation Choke Point 2.0, observers believe. Ascertaining the credibility of this claim would again mean looking into the chronological details of how these banks’ operations were made to evolve in the recent past concerning their crypto exposure levels.

Silvergate Bank

On December 6, Senators Elizabeth Warren, John Kennedy, and Roger Marshall rebuked Silvergate in a letter for offering services to FTX and Alameda Research and failing to preempt suspicious activities relating to these two institutions.

The effect of this letter snowballed into Silvergate stocks falling to a low of $11.55, while its price was hovering around US$160 in March 2022, less than a year ago.

Crypto-related deposits of the bank plunged 68% in the fourth quarter, and the bank had to liquidate its balance sheet securities. However, the draining out of funds was so severe that the US$718 million it lost selling the debt far exceeded the bank’s total profits since at least 2013.

Signature Bank

Immediately after Senator Warren, Kennedy, and Marshall’s letter, on December 7th, Signature Bank appeared pressurized as it announced to halve deposits ascribed to crypto clients. The bank declared it would return customers their money before eventually shutting down their accounts.

Signature’s decision ended up creating pressure on crypto industry players. Binance, one of the most well-known names in the crypto field, said that the Signature Bank’s policy decision compelled them to only process fiat transactions worth more than US$100,000.

Signature Bank’s eventual fall was another instance of a crypto-friendly bank succumbing to US crypto laws and regulatory constrictions preceding it. Numbers show that out of Signature Bank’s nearly US$88 billion deposits, 16.52 billion was from digital asset-related clients.

Silicon Valley Bank

The deposit drain, induced by regulatory tightening, compelled Silicon Valley Bank to sell off its underwater assets. The failure of SVB is another instance that helped choke the crypto industry.

The startup-focused Silicon Valley Bank held US$3.3 billion of US crypto firm Circle’s USD 40 billion coin reserves. Crypto lender BlockFi also had nearly US$236 million tied to ‘market mutual funds’ operated by SVB.

Other crypto businesses that Silicon Valley Bank was exposed to included Avalanche, Yuga Labs, Nova Labs, Dapper Labs, and Proof.

All These to What End?

If discouraging crypto-friendly banks - often to disastrous ends - is a well-coordinated attack by US regulators, there must be a reason, an objective the regulators would want to meet at the end of it all.

Many believe the process of cutting off crypto-friendly banks from the ecosystem is nothing but eradicating competition from the way of the long-awaited Fed digital payment system, scheduled to launch in July.

FedNow, the Federal Reserve’s digital payments system, has promised to be a cutting-edge, resilient, adaptive, and accessible solution. However, the solution fulfilling its potential would require institutional support. It would need undivided attention to make it glitch-free, especially in the initial onboarding days.

The program executive and first vice president at the Boston Fed, which helped actualize the project on the ground, already issued statements urging financial institutions to buckle up.

“With the launch drawing near, we urge financial institutions and their industry partners to join the FedNow Service” were his exact words.

It is also a fact that FedNow does not leverage distributed ledger technology, and its aim is limited to complementing Central Bank Digital Currencies. Vehement presence of crypto alternatives that fruitfully utilize the benefits of distributed ledgers might therefore be a cause of insecurity for the promoters of FedNow.

Many industry observers claim that the Fed expects the FedNow to become a crypto killer by offering cheap, reliable, and irreversible payment settlements within seconds through its system.

However, Bitcoin, the representative asset of the crypto industry, can already ‘trustlessly’ settle nearly 2,000 payments. It also follows the practice of waiting for five additional block confirmations to ensure the irreversible settlement of funds.

With what we all have seen so far, grappling with the behemoth of crypto assets without embracing the sheer brilliance of blockchain and Distributed Ledger Technology (DLT) might seem like an impossible task for mere mortals. But fear not, for the mighty Federal Reserve has already taken matters into its own hands. With a knowing wink and a nudge, they wield their regulatory powers to ever so subtly skew the playground in their favor, leaving non-Fed competitors gasping in awe at their cunning mastery of the game.