Cryptocurrency

Crypto firms could access Federal Reserve system under Senate bill – The Washington Post


Placeholder while article actions load

A wave of notoriously risky cryptocurrency firms could one day be integrated into the traditional banking system under a little-noticed provision in a new bill that is raising alarms among financial experts about potentially destabilizing consequences.

The provision — part of a sweeping proposal to regulate the crypto industry that Sens. Cynthia M. Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) introduced in June — would force the Federal Reserve to grant so-called master accounts to certain crypto firms seeking them from the central bank. The accounts give holders access to the Fed’s payment system, allowing them to settle transactions for clients without involving a separate bank.

Two Wyoming-based crypto firms championed by Lummis stand to benefit. Both companies, Custodia Bank and Kraken Financial, have been stymied over the last two years in bids to gain Fed master accounts. But financial regulators and experts say the measure’s impact would cascade through the industry and beyond.

The push by crypto firms to join the banking system’s central plumbing comes at a fraught moment for the industry and its regulators. A steep sell-off in cryptocurrencies has erased $700 billion from the digital asset market since early May, forcing a reckoning for some previously highflying start-ups, including firms attempting to bridge the divide between the crypto economy and traditional finance. One such firm, Celsius Network, halted withdrawals last month, citing “extreme market conditions” as it froze as much as $8 billion in deposits.

Crypto industry scores a big win under long-anticipated Senate bill

Even before the latest meltdown, the Federal Reserve had been reluctant to grant master accounts to crypto-focused banks. In Custodia’s case, Federal Reserve Chair Jerome H. Powell has cited his concerns about unleashing a tide of other crypto companies offering banking services while lacking federal insurance backstop.

“If we start granting these, there will be a couple hundred of them soon,” Powell told Lummis when she pressed him on the matter at a January congressional hearing.

Under Wyoming law, those banks can put their reserves into more volatile assets than their federally regulated counterparts — such as corporate and municipal debt — which could prompt a run 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 could have entities with poor risk management and poor risk controls integrated into the Fed’s payment system.”

Crypto’s frozen mystery: The fate of billions in Celsius deposits

The longer-term result could be a new buildup of systemic risk akin to what has preceded other financial meltdowns, some experts say. “I’m very concerned about the idea that uninsured banks of any type would have access to Fed services and more broadly proliferate, because we’ve had very bad experience with non-federally insured banks in the past,” said Arthur Wilmarth, an emeritus law professor at George Washington University and an expert on financial regulation. “I’m concerned they’ll become systemically important, and we could end up needing to bail them out if it looks like they’re going to fail.”

Proponents counter that giving more firms access to the central bank’s payments infrastructure will have the opposite effect, shoring up the crypto economy by giving federal overseers a better view of its activity. “Giving more regulated financial institutions access to the payment system reduces risk because it allows more visibility into who owes what,” a Lummis aide said. “And if there’s a systemic crisis, if a bank were to fail, there wouldn’t be as many ripple effects in the economy.”

Now, the Fed is facing increased pressure to act. On June 7, the same day Lummis and Gillibrand introduced their bill, Custodia sued the Federal Reserve and its Kansas City regional bank in federal district court in Wyoming, accusing it of unlawfully delaying action on its application 19 months after it was filed. (The timing was a coincidence, a Lummis aide said.)

The company, founded by Morgan Stanley veteran Caitlin Long, set up shop in Wyoming in 2020 to take advantage of special rules the state adopted the year before to attract firms looking to mix traditional banking activities with crypto transactions. Shortly after securing its state charter, it applied for a Fed master account. In the months since, “what has resulted is an unaccountable Kafkaesque process that has and continues to inflict grave, irreparable harm on Custodia,” the firm said in its suit.

The company has cast itself as a David taking on the Goliaths of Wall Street. “If federal regulators continue to hold back innovators like Custodia, they are only letting the big banks catch up and gobble up the market,” Custodia spokesman Nathan Miller said. “That leaves consumers with fewer choices and higher bank fees at a time when American families are struggling with inflation and economic insecurity.”

The Federal Reserve and the Kansas City Fed declined to comment.

Kraken, for its part, is primarily known as a crypto exchange, operating the second-largest such trading platform in the United States. But an affiliate known as Kraken Bank in 2020 secured the first charter under Wyoming’s carveout for crypto banks, pledging to provide clients “a seamless banking gateway” between digital assets and traditional currencies.

When Kraken Bank applied for its own Fed master account shortly thereafter, a united front of banking lobbying groups pushed back. In a letter to the Fed, the coalition warned that Kraken’s business model presented “novel risks,” pointing to the company’s lack of federal oversight as it hosts leveraged trading of volatile digital assets. Amid a stark downturn for the crypto industry that has prompted several of its rivals to cut staff, Kraken, which is privately held, this month said it plans to add 500 employees. The company declined to comment.

The Fed is in the midst of developing standards for granting master accounts, a process whose murkiness has drawn criticism from Republicans in Congress.

Crypto’s meltdown refocuses regulator attention on the industry

The matter took center stage earlier this year in a partisan fight over the nomination of Sarah Bloom Raskin to serve as the Fed’s top financial regulator. Raskin served on the board of Reserve Trust, a Colorado payments company, when it secured a master account in 2018 after being denied one a year earlier. Lummis and other Republicans on the Senate Banking Committee pressed Raskin on whether she wielded her influence as a former Fed official to help the firm. Raskin denied any impropriety.

But the episode helped sink her nomination. In its wake, the Kansas City Fed revoked Reserve Trust’s master account. Sen. Patrick J. Toomey (R-Pa.), the top Republican on the Senate banking panel, wrote to the bank in June asking for details on 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 a bigger point: As financial technology start-ups angle to compete with traditional banks, the Fed needs to explain its standards for doling out access to its payment rails. Lummis told Powell at a hearing in June that the process remains a “black hole” and said her frustration with it is “at a boiling point.”

The Fed is considering adopting a system that would subject firms that are not federally insured or federally regulated to stricter scrutiny. Dennis Kelleher, president of the nonprofit Better Markets, which advocates stricter financial regulation, said the details will matter, but the approach “would likely be the worst of all worlds,” granting crypto firms access to the Fed’s payment infrastructure “without the regulations imposed on banks. The result would be the appearance of protecting taxpayers and the financial system but not the reality.”



READ SOURCE

This website uses cookies. By continuing to use this site, you accept our use of cookies.