Crypto is facing a banking crisis. For some it is a conspiracy

– There was absolutely no warning, says Klippsten. “We got no phone call, no email, no letter – nothing. They just shut it down.”

Swan had a secondary account in another bank and could therefore still withdraw wages, but for a smaller company this could have been an “existential threat”, says Klippsten. Citibank did not respond to a request for comment.

The crypto industry needs banking services; it needs it badly and always has. Without a banking partner, crypto companies cannot accept dollar deposits in return for services or in exchange for tokens, nor can they pay their employees or suppliers. This means that the quest to build a parallel financial system free of intermediaries is impractically dependent on an agreement with the same intermediaries – the banks.

Wall Street has often been reluctant to work with crypto companies, so many in the industry came to rely on just two US banks – Silvergate and Signature – which made themselves invaluable to crypto customers by offering real-time payments outside of traditional banking hours. Over the past week, both banks have closed, Silvergate due to overexposure to the ailing crypto sector and Signature due to a liquidity crisis triggered by a sudden flood of withdrawals. As a result, many crypto businesses – especially smaller ones – are back where they started: unbanked and with few options at hand.

“Overwhelmingly, banking is the challenge for crypto companies,” says William Quigley, co-founder of stablecoin issuer Tether. “A lot of people in crypto are denied access to banking services. It’s a real problem.”

When the crypto space began to grow in the early 2010s, mainstream banks were often hesitant to work with a sector they saw as inherently risky. But as the industry began to move closer to the mainstream in recent years, Wall Street’s comfort level grew. Big banks like JPMorgan and BNY Mellon started banking crypto exchanges and allowing their customers to store and trade coins. Regulators kept an eye on the sector, but apart from some “policy sprints” they did little.

Then in 2022, crypto collapsed spectacularly. In May, the failure of the Terra-Luna stablecoin wiped out an estimated $60 billion, sparking a chain reaction that later brought down crypto lender Celsius, hedge fund Three Arrows Capitals and others. This was followed in November by the implosion of crypto exchange FTX, whose founder has since been charged with 12 criminal offences, including bank fraud, bank fraud and money laundering.

The fallout from the destruction of large parts of the crypto ecosystem didn’t really spread to the mainstream financial sector, but regulators felt compelled to make sure it stayed that way. In a joint statement on January 3, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), the agencies responsible for the stability of the US banking system, claimed that crypto represents a “significant risk” to “It is important that risks associated with the cryptoasset sector that cannot be mitigated or controlled do not migrate to the banking system,” the agencies wrote, although they also made it clear that US banks are “neither prohibited nor discouraged” from servicing crypto businesses.

Since the beginning of the year, statements from regulators and the White House have further warned banks to limit exposure to crypto. In late January, the Fed also announced that it had denied Custodia, a state-chartered bank that offers cryptocurrency custody services, applications to join the Federal Reserve System and open a main account, which would have allowed the firm to compete on a level playing field with large national banks.

Almost all the household names in crypto – and many smaller ones – were drawn to the two institutions that remained crypto-friendly: Silvergate and Signature.

Silvergate fell first. The bank had been struggling since the collapse of FTX and its sister company Alameda Research – both of which were also clients – which led to billions of dollars in withdrawals from clients. On March 8, the bank announced that it was winding up. The US Department of Justice is reportedly conducting an investigation into Silvergate regarding services provided to FTX and Alameda.

The situation at Signature was different. Since December, the bank had tried to diversify its customer base to avoid the same concentration risk that Silvergate hit. But it seems that its reputation as a crypto bank, combined with panic in the wake of the failure of Silicon Valley Bank (SVB), was enough to drive another fatal run on deposits, leading to the FDIC seizing the bank 12 March. .

In an interview with Bloomberg on Sunday, Signature board member Barney Frank, the former congressman responsible for US banking reforms in the wake of the 2008 financial crisis, said the bank could have survived but that regulators “wanted to send a message to get people away from crypto.”

The US Treasury Department did not respond to a request for comment. The Federal Reserve and the FDIC declined to comment on the record. Stephanie Collins, head of media relations at the OCC, noted that the agency does not oversee Silvergate or Signature, but did not address questions about coordination among U.S. banking regulators. But in a statement provided to Reuters, the New York State Department of Financial Services, which handed over Signature to the FDIC, said that “the decisions made over the weekend had nothing to do with crypto.”

But the idea that regulators have it in crypto has weight in some parts of the industry. Even before Silvergate and Signature shut down, members of the crypto community – included CEO of the American crypto exchange Kraken— cried conspiracy, calling it “Operation Choke Point 2.0,” or a coordinated effort to cut off crypto from the banking system.

The term, coined by Nic Carter, general partner at VC firm Castle Island Ventures, refers to a program launched by the Obama administration in which US officials were said to have pressured banks to sever ties with unfavorable industries such as pornography and payday loans.

Proponents of the Choke Point 2.0 theory say the moves are a renewed attempt to regulate by stealth — using leverage over the banking sector to make de facto policy without requiring congressional approval. “For now, most banks are terrified to monetize crypto, so the policy has been a success without requiring a ban,” Carter says. “The goal is to do as much as possible without having to pass new laws.”

A group of Republican senators, led by Bill Hagerty of Tennessee, wrote a letter to bank regulators on March 9 supporting this interpretation. The statements issued by regulators have “caused banks to reconsider their decision to provide banking services to the crypto sector,” the letter claimed. “This coordinated behavior seems disturbingly reminiscent of Operation Choke Point.”

“Operation Choke Point 2.0 is very real,” says Caitlin Long, CEO of Custodia, the scorned bank. “Many banks have gone way back in their crypto activities… and many [crypto] companies ranging from small to very large are looking for bank accounts.”

Since January, Custodia has been inundated with inquiries from crypto companies looking for a banking partner, Long says, but without federal oversight it can only offer a limited range of US dollar services. Custodia is suing the Fed for rejection of its application for membership.

Others are less convinced by the Choke Point theory. Economist Frances Copolla, who worked in risk management for HSBC and the Royal Bank of Scotland, says she does not believe there has been a “coordinated attack on crypto” but that the failure of Silvergate and Signature is a reflection of the fragility of their operating models. Caleb Franzen, a corporate banking analyst at research firm Cubic Analytics, says talk of underhanded tactics among regulators is “pure speculation.”

But whether by accident or design, crypto is facing a banking crisis in the United States.

The closure of Silvergate and Signature has sent crypto companies scrambling for new banking partners. Circle Internet Financial, whose USDC stablecoin was temporarily delinked from the dollar due to exposure to Silvergate and SVB, arranged over the weekend to expand an existing relationship with BNY Mellon. But not everyone is home and dry; crypto investment companies MaiCapital and Digital Asset Capital Management have taken the search for new banking partners offshore, while trading platform LedgerX has been forced to find a new bank for the second time, after first switching from Silvergate to Signature. Neither company responded to a request for comment.

By virtue of the value they represent to banks, larger crypto companies will likely be able to keep their existing accounts in the US, Carter says, meaning US residents will still have access to crypto exchanges. But smaller companies “scramble”, he says. The result is likely to be that some businesses will migrate to countries with more favorable regulatory regimes; some will struggle to raise risk capital, which is conditional on access to banking services; and others won’t start at first, says Carter.

With the downfall of Silvergate and Signature, the only two banks that offer real-time payments anytime, any day, the 24/7 crypto industry will have to get used to operating at a different pace. For traders, this means an inability to exit bets outside normal banking hours, which is likely to create an additional level of volatility.

Swan Bitcoin’s Klippsten doesn’t buy into the idea that US regulators have launched a coordinated attack on the crypto industry, driven by “a man behind the curtain pulling the strings”. He is also more keen on the prospect of the companies “orphaned” by Silvergate and Signature finding new banking partners, saying “banks are usually happy to take your money.”

Klippsten is also sympathetic to regulators’ ambition to defend against fraud in the crypto sector. But the frustration, he says, is that legitimate crypto companies will be collateral damage.

“Because crypto is so shady and some of the businesses are so poorly run, the whole category is toxic — it’s a pile of dog shit, on average,” he says. “So it’s hard to ask a bank with hundreds of thousands of accounts to distinguish between good crypto businesses, run by grown adults, [and bad ones]. We are stuck and being painted with the same brush.”