Acting Comptroller Discusses Crypto Risk, Including Use of Bank-Like Terminology | Ballard Spahr LLP
IN remarks at the DC Fintech Week conference on October 11, 2022 and in a keynote address later that day at a roundtable conducted by the Harvard Law School Program on International Financial Systems, Acting Comptroller of the Currency Michael J. Hsu expressed concerns about the risks to consumers and the financial system posed by participants in the crypto industry.
Acting Comptroller Hsu identified risks created by crypto companies’ use of bank-like terminology; integration and combination of services both between banks and crypto firms, and within the crypto industry; and gaps in data necessary to understand the risk of exposure to crypto assets in traditional banks.
Regarding the terminology and marketing approaches used by crypto companies, Acting Comptroller Hsu warned that by using “skeuomorphism,” a design concept in which a new product or process appears to be the same as a known product or process, “crypto has imitated ” familiar concepts related to traditional financial products and services to suggest to the public that crypto products are analogous to banking products. As an example, Mr. Hsu pointed to “crypto savings accounts” offered by crypto companies on their platforms. These accounts promise consumers returns paid in additional crypto units which is sometimes referred to as “yield” and quoted in terms of “APY”, thus implying a stable, predictable return. In some cases, consumers are assured that they can reclaim their assets at any time, even if the crypto company fails .
While Mr. Hsu did not refer to the crypto companies’ claims as “misleading” or “misleading,” his comments reflect skepticism about approaches the crypto industry has used to draw consumers away from traditional banking relationships. He noted that “[a]as many are now learning the hard way, the risks of these schemes are significantly different from their representations,” and warned that “[i]In these examples, skeuomorphism is not a bridge but a disguise. Using the familiar to introduce something new can downplay or mask the risk and establish false expectations. Over time, people get hurt.” In later remarks, Hsu reiterated the same theme: “A large segment of the crypto-asset industry continues to rely on hype and bootstrapping to grow. Promises of innovation and inclusion often mask crypto’s promotion of a gold rush sentiment…”.
Regarding integration and combined concerns, Hsu cited fears not only of the integration of crypto and traditional finance, but also of overreaching by crypto companies looking to offer an ever-widening range of services, such as: “digital wallets; buying and selling crypto; crypto depository; staking crypto for returns; crypto margin loans; crypto derivatives trading; keeps fiat; loans and payments by credit card; direct deposit of paychecks; facilitating peer-to-peer payments; issue stablecoins; and create, collect and connect NFTs.” He expressed the view that until crypto matures and appropriate guardrails are put in place, limits should be placed on the scope of activities mixed in a single crypto firm and on the integration of crypto and traditional finance.
Regarding the lack of availability of data necessary to identify, understand and monitor risks related to crypto activities, Hsu cited supervisory processes in place to monitor banks’ exposure to crypto and to gain insight into their crypto activities, such as the requirement of that institutions first obtain a regulatory no-objection before engaging in any of the crypto-asset activities that the OCC has determined to be permitted. To receive a no-objection, an institution must demonstrate that it can perform the proposed activity safely, responsibly and fairly. He noted that the FDIC and the Federal Reserve have adopted a similar approach, helping to maintain a level playing field throughout the banking system. He also warned that while this approach has been effective in monitoring banks’ crypto-related activities, further improvements may be needed to track the risk of “cross-contagion.” He indicated that the OCC is considering enhanced supervisory processes to better understand “the prevalence and extent of exposures to cryptoassets and interconnection at our supervised institutions.”
Acting Comptroller Hsu went on to suggest options for imposing oversight and, ultimately, regulation on the crypto industry, while not clearly identifying an optimal way to achieve this goal, or which regulator(s) should be responsible . He suggested that collecting data from crypto firms and platforms about their activities with traditional financial institutions would give financial stability regulators a more complete picture, thereby enabling more effective monitoring of financial stability risks. He also suggested that such monitoring in the US could be carried out by the Office of Financial Research (OFR), and that in light of crypto’s borderless nature, international coordination should be considered.
Mr. Hsu also discussed additional considerations that need to be kept in mind with regards to “bringing crypto into the regulatory perimeter.” He observed that “crypto participants (and fintechs in general) can choose from a menu of regulators and regulatory perimeters” and that “[t]the line between well-adapted regulation and unnecessary accommodative regulation can be unclear [with the possibility that] Attracting crypto licensees and activities could be a sign that a regulator may have overreached the industry.” He indicated that “[c]cooperation and coordination between financial regulators can serve as an effective mitigation of the risk of overstaying” and “is particularly important as long as crypto businesses are not subject to extensive oversight where a single authority has visibility into a firm’s overall activities.”
Mr. Hsu concluded his remarks by commenting that while he is skeptical of crypto’s real utility and concerned about the risks it poses to consumers and the financial system, he is not prepared to “say with certainty that crypto is useless and should go away. ” He stated that his role as a banking regulator “is to ensure that the banking system is safe, sound and fair – not to pick winners and losers among new technologies.”
We note that Mr. Hsu is not the only federal regulator to have expressed growing concerns about crypto. Recent FDIC and CFPB issuances included warnings about crypto companies’ deceptive advertising practices, as discussed in our recent blog posts and podcast.
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