A wave of notoriously risky cryptocurrency firms may one day be integrated into the traditional banking system under a little-respected provision in a new bill that raises alarm among financial experts about potentially destabilizing consequences.
Cryptocompanies can access the Federal Reserve system under Senate bill
Two Wyoming-based crypto companies championed by Lummis could benefit. Both companies, Custodia Bank and Kraken Financial, have been barred over the past two years from bidding for Fed accounts. But financial regulators and experts say that the impact of the measure will flow through the industry and beyond.
The pressure from crypto companies to join the banking system’s central plumbing work comes at a difficult time for the industry and its regulators. A sharp sell-off of cryptocurrencies has wiped out $ 700 billion from the digital asset market since early May, forcing a bill for some former high-flying start-ups, including firms trying to bridge the gap between the crypto-economy and traditional finance. One such company, Celsius Network, stopped withdrawals last month, citing “extreme market conditions” when it froze as much as $ 8 billion in deposits.
Even before the recent meltdown, the Federal Reserve had been reluctant to give main accounts to cryptocurrency-focused banks. In Custodia’s case, Federal Reserve Chairman Jerome H. Powell has cited his concerns about unleashing a wave of other crypto companies offering banking services while lacking federal insurance backlog.
“If we start giving these, there will be a couple of hundred of them soon,” Powell told Lummis when she pressured him about the matter during a congressional hearing in January.
Under Wyoming law, these banks can put their reserves into more volatile assets than their federally regulated counterparties – such as corporate and municipal debt – which can lead to a race if they suddenly lose value, said Lee Reiners, a former Fed official who now runs Duke University’s Global Financial Markets Center. “The concern is that you may have devices with poor risk management and poor risk control integrated into the Fed’s payment system.”
The long-term result may be a new build-up of systemic risk similar to what has preceded other economic breakdowns, some experts say. “I am very concerned about the idea that unsecured banks of any kind will have access to Fed services and spread more widely, because we have had very bad experience with non-federally insured banks in the past,” said Arthur Wilmarth, an emeritus law professor at George Washington University and financial regulation expert. “I’m worried they’ll become systemically important and we may end up having to save them if it looks like they’re going to fail.”
Proponents argue that giving more companies access to the central bank’s payment infrastructure will have the opposite effect, and strengthen the crypto-economy by giving federal supervisors a better overview of activity. “Giving more regulated financial institutions access to the payment system reduces the risk because it gives more insight into who owes what,” said an assistant from Lummis. “And if there is a systemic crisis, if a bank were to fall, there would not be as many ripple effects in the economy.”
The Fed is now facing increased pressure to act. On June 7, the same day that Lummis and Gillibrand presented their bill, the Custodia Federal Reserve and its regional bank in Kansas City sued in the federal district court in Wyoming, accusing it of illegally delaying the action on the application 19 months after it was filed. filed. (The timing was coincidental, said an assistant from Lummis.)
The company, founded by Morgan Stanley veteran Caitlin Long, established a store in Wyoming in 2020 to take advantage of special rules the state adopted the year before to attract companies that want to mix traditional banking activities with crypto transactions. Shortly after securing its government charter, it applied for a Fed main account. In the months that followed, “what has resulted is an inexplicable Kafkaesque process that has and continues to inflict serious, irreparable damage on Custodia,” the company said in its case.
The company has thrown itself out as a David taking on Goliaths of Wall Street. “If federal regulators continue to hold back innovators like Custodia, they’re just letting the big banks catch up and devour the market,” said Custodia spokesman Nathan Miller. “It gives consumers fewer choices and higher bank charges at a time when American families are struggling with inflation and economic uncertainty.”
The Federal Reserve and the Kansas City Fed declined to comment.
Kraken, on the other hand, is primarily known as a crypto exchange, which operates the second largest trading platform in the United States. But an affiliate known as Kraken Bank in 2020 secured the first charter during Wyoming’s carveout for crypto banks, promising to give customers “a seamless banking gateway” between digital assets and traditional currencies.
When Kraken Bank applied for its own Fed main account shortly afterwards, a united front of banking lobby groups pushed back. In a letter to the Fed, the coalition warned that Kraken’s business model presented “new risks”, pointing to the company’s lack of federal supervision as it hosts trading in volatile digital assets. In the midst of a sharp decline for the crypto industry that has led several of its competitors to cut employees, Kraken, which is privately owned, said this month that they plan to add 500 employees. The company declined to comment.
The Fed is in the midst of developing standards for the allocation of master accounts, a process that has been criticized by Republicans in Congress.
The case became central earlier this year in a biased battle over the nomination of Sarah Bloom Raskin to serve as the Fed’s chief financial regulator. Raskin sat on the board of the Reserve Trust, a payment company in Colorado, when it secured a main account in 2018 after being denied one a year earlier. Lummis and other Republicans on the Senate Banking Committee pressured Raskin on whether she had her influence as a former Fed official to help the firm. Raskin denied any inappropriate action.
But the episode helped lower her nomination. In the wake of that, the Kansas City Fed recalled the Reserve Bank’s principal account. Senator Patrick J. Toomey (R-Pa.), The top Republican on the Senate banking panel, wrote to the bank in June asking for details of the decision. The Kansas City Fed rejected his request, citing the need to protect the confidentiality of a private company and the bank’s own process.
Republicans are pushing for a bigger point: Since emerging financial technologies want to compete with traditional banks, the Fed must explain its standards for allocating access to the payment rails. Lummis told Powell at a June hearing that the process is still a “black hole” and said her frustration with it is “at a boiling point.”
The Fed is considering using a system that will subject companies that are not federally insured or federally regulated to stricter controls. Dennis Kelleher, president of the non-profit organization Better Markets, which advocates stricter financial regulation, said the details would matter, but the approach “would probably be the worst of all worlds,” giving crypto firms access to the Fed’s payment infrastructure “without the regulations “The result would be the appearance of protecting taxpayers and the financial system, but not reality.”
