Times Are A-changing for Cryptocurrencies

Reading some official government documents can be a little like trying to decipher ancient Sanskrit. Hidden deep in the complex sentence structure and past the heavy infusion of jargon and legalese, it is possible to understand the intentions of policymakers – if you look hard enough.

But the latest missive from federal banking regulators on the risks of cryptocurrencies is crystal clear in its meaning, and the bureaucrats who wrote it pull no rhetorical punches.

The joint statement from the Federal Reserve Board, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency outline in some detail the federal government’s perspective on the inherent risks of digital currencies to financial institutions, and provide what could become the roadmap to regulatory oversight of cryptocurrencies.

The statement lists “key risks” associated with digital currencies that banking organizations should be aware of, and the words “fraud,” “scams,” “misleading,” “deceptive,” “abusive” and “illicit” are liberally sprinkled throughout the text. And for anyone still unclear about government intentions, the agencies spell out their fundamental purpose: “It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system.”

That is a clear signal that government regulators will not wait for a legislative solution to any potential threats cryptocurrency presents but intend to use existing banking rules to erect a type of Chinese wall around the banking system to insulate it from risks.

The Chinese wall concept has been part of the business world for a long time and refers to a virtual barrier intended to block the exchange of information between departments if it could result in business activities that are ethically or legally questionable. In the brave new world of digital assets, it means if federal agencies do not yet have the power to keep cryptocurrencies out of the wider economy, they will use existing financial regulations to keep it out of the banking system.

While the Fed, the FDIC and the Comptroller of the Currency recognize that banks are not currently prohibited from providing services to customers using digital currencies, the joint statement makes it clear that as far as they are concerned, given the current nature of the cryptocurrency market, any activity by federally regulated banks in digital assets “is highly likely to be inconsistent with safe and sound banking practices.”

The words “safe and sound” are not just a nice alliterative turn of phrase, but reference specific obligations of financial services organizations to ensure they are not taking outsized risks that could imperil their balance sheets. In the wake of the 2007-2008 financial crisis that resulted in the collapse of Lehman Brothers and pushed the global economy into a tailspin, federal regulators have conducted a series of “stress tests” on banks to make sure the institutions have the proper policies and controls in place to weather another financial storm, and requiring those who fail the tests to make changes in their operations.

Using that model, it appears federal regulators are ready, willing and able to take steps to keep the volatility of cryptocurrencies from infecting the financial system and causing another global meltdown.

Right now, federal comment on the situation seems to be couched more as strong suggestions than actual official regulations. But like Bob Dylan said, the times, they are a-changing.