With the Sam Bankman-Fried trial over, can banks get back into crypto?

Before the cryptocurrency exchange FTX collapsed last November, there were four U.S. banks serving cryptocurrency businesses to any significant extent: Silvergate Capital, Signature Bank, Farmington State Bank and Metropolitan Bank. 

Now there are none. 

In January, New York City based Metropolitan Bank announced it would “fully exit the crypto-asset related vertical,” six days after the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. put out a joint statement on crypto-asset risks to banking organizations. In March, Silvergate Capital and Signature Bank were shut down by regulators. Farmington State Bank shut down in April after receiving a cease-and-desist order from federal regulators.

With the FTX trial over and its founder, Sam Bankman-Fried, convicted of seven counts of fraud, will banks be able to take on crypto-related businesses and offer crypto services with the blessing of their regulators?

‘Crypto is not evil’

The FTX case has been a setback for the entire crypto industry, noted Sam Taylor, head of corporate intelligence, Americas at consulting firm S-RM.

A couple of years ago, cryptocurrency was becoming more generally accepted.

“With all the Super Bowl commercials, there was in many ways a legitimization of the product to retail investors through spokespeople like Tom Brady and Larry David,” Taylor said. “And it appeared to be becoming mainstream to retail investors. This does set that back quite a bit. I think the broader public is going to be increasingly skeptical now for several years about decentralized finance and cryptocurrency.”

But the FTX fiasco doesn’t necessarily give the crypto industry a permanent black eye, he said.

“The cryptocurrency industry has always struggled to gain legitimacy and was gaining a lot of momentum going into this,” Taylor said. “So I would say [the FTX collapse] does slow it down. I wouldn’t say forever.”

Some say bank regulators have taken too harsh a stance toward cryptocurrency businesses.

“It’s clear federal officials overreacted to the FTX fraud in their coordinated effort to paint all digital asset start-ups with the same broad brush, which wasn’t true,” said Caitlin Long, CEO of Custodia Bank in Wyoming. “It’s also clear some federal officials thought their crackdown would drive digital assets to zero, which didn’t happen. In the year since, federal courts and the General Accounting Office have been striking down or casting doubt on the legality of their regulatory overreach.”

The FTX case was a matter of fraud, not a cryptocurrency issue, and the cryptocurrency industry isn’t the only place fraud exists, noted Renato Mariotti, former federal prosecutor and partner at Bryan Cave Leighton.

“Banks get defrauded all the time, but that doesn’t mean that they stop lending money,” he said. “Crypto is not inherently evil or illegal or problematic,” Mariotti said. “It’s an asset. You could view it as a development in technology.”

The lack of an established regulatory framework for cryptocurrency is an issue and brings regulatory uncertainty for financial institutions.

“Obviously the industry’s asking Congress to adopt such a framework, but Congress has not done so at this time,” Mariotti said. “As a result, there’s a lot of civil litigation between the SEC, CFTC and various market participants.” 

State of the market

A few banks, including JPMorgan Chase, Citi and BNY Mellon, offer certain narrow digital asset services to mainstream clients. Vast Bank in Tulsa, Oklahoma, lets customers buy and sell cryptocurrencies through its mobile banking app, through a partnership with Coinbase. One digital assets company, Anchorage Digital Bank, has a national bank charter from the Office of the Comptroller of the Currency that it uses to provide crypto custody. 

But even in the case of crypto activities that seem harmless, like providing custody for clients’ digital assets, regulators have been discouraging. Long’s Custodia Bank, which received a special purpose depository institution license from Wyoming more than three years ago, has been blocked by the Federal Reserve from access to a master account. Custodia intends to provide crypto custody to institutional investors. Last year, hundreds of banks that were working with NYDIG, a New York technology company, and preparing to let consumers track their bitcoin purchases and sales through their mobile banking apps, were told by the FDIC to slow down, according to people familiar with the matter.

It’s also difficult for crypto companies to have their own bank accounts, as normal businesses do. Large, profitable and well-established crypto companies like Coinbase usually are able to get them. (Coinbase also has a trust bank charter from the New York State Department of Financial Services.) But it’s much harder for smaller companies and startups.

Bank regulators’ cautionary statement in January did not prohibit banks from banking crypto companies, but discouraged it. 

“The agencies believe that issuing or holding as principal crypto assets that are issued, stored or transferred on an open, public, and/or decentralized network or similar system is highly likely to be inconsistent with safe and sound banking practices,” the statement said. “Further, the agencies have significant safety-and-soundness concerns with business models that are concentrated in crypto-asset-related activities or have concentrated exposures to the crypto-asset sector.” In response to requests for interviews, regulators pointed to the OCC’s Interpretive Letter 1179, which says certain activities are legally permissible for banks, provided they can demonstrate that they have controls in place to conduct the activity in a safe and sound manner. These activities include cryptocurrency custody and holding deposits that serve as reserves for stablecoins. 

Observers say there has been an Operation Choke Point 2.0 in effect on banking crypto companies for more than a year. 

Some say the way to mitigate risk for crypto markets and investors is not to keep banks away from crypto, but to let them in. This would reduce the concentration risk of having a few banks serve a large market and in turn, reduce the risk of a run on these banks. It could also help instill compliance procedures and regulatory oversight over the movement of digital assets. 

Another facet of this argument is that cryptocurrencies are not illegal and they are not going away.

Due diligence of crypto-related companies

Banks that worked with Alameda and FTX, including Deltec, Farmington State Bank, Signature Bank and Silvergate Capital, have been scrutinized for these relationships. 

“A robust due diligence process could have yielded a lot of information that might have given an investor serious pause and perhaps at least gone in more clear-eyed as to what they were getting into,” Taylor said. “The lack of controls at Alameda and FTX, the lack of an adult in the room. I think if any company wanted to do business with a group of people like Sam Bankman-Fried and his lieutenants living in the Bahamas, immediately that makes me think we ought to do some form of deep dive due diligence.”

But it’s hard to say whether such red flags were clear when those bank accounts were originally opened. 

“By its very nature, fraud involves deception and concealment, which can make it difficult to detect,” Mariotti said. “Until there’s an established regulatory framework in place for this space, anyone looking to do business in the crypto space needs to really dig in and do their homework.”

One thing to look for, he said, is whether a potential customer or client has a “culture of compliance, is robustly engaging with regulators and is committed to full transparency.”

But the lack of a regulatory framework makes due diligence harder, Mariotti pointed out.

“If you had the CFTC or the SEC regulating the space and promulgating regulations and requiring filings and there were audits by FINRA or another government agency, it would just be a different situation,” Mariotti said. “You would catch more things.”

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