Crypto’s US banking access more uncertain than ever

Crypto’s continued access to U.S. banking rails appears less certain by the day, despite several Hail Mary rescue plans in the works.

Late last week, struggling California-based Silvergate Bank updated its website with the following banner message:

“Effective immediately Silvergate Bank has made a risk-based decision to discontinue the Silvergate Exchange Network (SEN). All other deposit-related services remain operational.”

For the uninitiated, SEN was a 24/7 settlement network that allowed Silvergate’s digital asset exchange clients to conduct large transactions outside regular banking hours. SEN was so popular that now-disgraced FTX founder Sam Bankman-Fried (SBF) once described it as “one of the key backbones of the cryptocurrency settlement layer.”

Silvergate has been living on borrowed time since it failed to file its latest financial report with the U.S. Securities and Exchange Commission (SEC) by the already extended deadline. The announcement of this failure included a stark warning regarding the bank’s ability to carry on as a going concern once those numbers are finally released.

Silvergate was hit by a tsunami of withdrawals following last November’s collapse of FTX, which forced the bank into the early loss-making sale of its long-term securities. Silvergate also borrowed over $4 billion from a federal program intended to ensure banks could continue to issue mortgages, but this loan was called in after several U.S. senators objected to the non-mortgage-related bailout.

On Monday, the brouhaha reached the Oval Office, as White House press secretary Karine Jean-Pierre was asked whether the administration was “monitoring” Silvergate’s situation. Jean-Pierre said the administration was “aware” of the situation, and reiterated President Joe Biden’s call for Congress and regulatory agencies to “take action to protect everyday Americans from the risk posed by digital assets” but declined to “speak to this particular company as we have not with other cryptocurrency companies.”

Late Tuesday, Bloomberg reported that U.S. federal officials were discussing some sort of Silvergate rescue plan. Last week, Federal Deposit Insurance Corp (FDIC) examiners descended on Silvergate’s offices to study the bank’s books and records. No details were forthcoming, but a rescue could potentially involve finding ‘crypto-industry investors’ willing to shore up Silvergate’s liquidity. (Too bad SBF is out of action, as he was a proper whiz with this bailout stuff.)

Silvergate shares closed Tuesday down 3.7% to $5.21, a mild improvement over its recent record low of $4.85 but a pale shadow of its $200+ peak during 2021’s speculative crypto value bubble.

Signature move

New York-based Signature Bank has its own 24/7 crypto settlement network called Signet that remains active, albeit for how much longer is anyone’s guess. Signature has very publicly declared its intention to reduce its crypto exposure, a stance that saw the bank’s total deposits decline by $17.5 billion last year, of which $12.4 billion was crypto-related.

Last week, Signature filed its annual 10K report for 2022 with the SEC and, for the first time, warned investors that “negative perceptions regarding certain industries, partners or clients could also prompt us to cease business activities associated with those entities.”

In another first, the 10K warned that if Signature, “our subsidiaries, or third-party service providers, are found to have failed to comply with applicable economic and trade sanctions programs and anti-money laundering laws and regulations, we could be exposed to fines, sanctions and penalties, and other regulatory actions, as well as governmental investigations.”

Signature further clarified that it “does not lend to the cryptocurrency industry, nor do we have any loans backed by cryptocurrency.” That’s a shift from Signature’s 10K for 2021, which noted that Signature “offers a loan product collateralized by certain cryptocurrencies,” including BTC.

The (federal) empire strikes back

U.S. banks are increasingly aware that any involvement with crypto firms will likely increase regulatory oversight of their overall operations. On Tuesday, Federal Reserve chairman Jerome Powell appeared before the Senate Banking Committee and was asked by Committee chair Sherrod Brown (D-OH) about the risks posed by digital assets.

Powell responded that “like everyone else we’ve been watching what’s been happening in the crypto space … what we see is … quite a lot of turmoil, we see fraud, we see a lack of transparency, we see run risk, lots and lots of things like that. What we’ve been doing is making sure that the regulated financial institutions that we supervise and regulate are careful, are taking great care in the ways that they engage with the whole crypto space and that they give us prior notice.”

One day before Powell’s comments, Michael Hsu, acting head of the U.S. Office of the Comptroller of the Currency (OCC), gave a speech at the Institute of International Bankers (IBB) Annual Washington Conference. Hsu said crypto’s narrative over the past year bore “striking similarities” to the 1991 failure of Bank of Credit and Commerce International (BCCI) following revelations of its involvement in money laundering, fraud, and a takeover of some American banks.

Hsu described Satoshi Nakamoto’s 2008 Bitcoin white paper as “elegant in its arguments,” but the current execution of that vision is “extraordinarily messy and complex. Nakamoto’s vision of peer-to-peer payments never took hold and has been virtually nonexistent. Rather, crypto has served primarily as an alternative asset class and the dominant activity has been trading. In addition, the activities of many key participants in the markets lack transparency.”

Hsu noted that BCCI and FTX “faced fragmented supervision … Both operated across jurisdictions where there was no established framework for regulators to share information on the firms’ operations and risk controls. Both used multiple auditors to ensure that no one could have a holistic view of their firms.”

As a result of this fragmented oversight, BCCI, and FTX “were able to carry out and obfuscate fraudulent activity and operate with a stunning lack of basic risk management and internal controls for an extended period of time, despite being ‘regulated.’ By seemingly being everywhere and structuring entities in multiple jurisdictions, they were effectively nowhere and were able to evade meaningful regulation.”

Hsu warned that, at present, “no crypto platforms are subject to consolidated supervision. Not one.” Until that situation changes, firms like FTX will go on “play[ing] shell games using inter-affiliate transactions to obfuscate and mask their true risk profiles.”

BCB, all that you can be

So, who would want to stick their necks into this banker-shaped guillotine? Enter one Oliver von Landsberg-Sadie, CEO of the BCB Group, the first crypto-focused company to be regulated as an Authorized Payment Institution by the U.K.’s Financial Conduct Authority.

In a recent interview with CoinDesk, Landsberg-Sadie noted that his company already provides fiat-to-crypto rails for digital asset exchanges like Bitstamp, Gemini, and Kraken for currencies including Euros, English pounds, Swiss francs, and Japanese yen. And like Silvergate/Signature, BCB has its own 24/7 settlement network, the BCB Liquidity Interchange Network Consortium (BLINC).

Landsberg-Sadie said BLINC has been working on adding USD to its list of supported currencies for a year and is preparing to launch “as quickly as possible.” Landsberg-Sadie vowed to “do whatever it takes to make sure those who are stranded by SEN get some sort of continuity given the huge overlap of BCB and Silvergate clients.”

Unlike SEN/Signet, BLINC isn’t tied to a single bank. Landsberg-Sadie called it “a decentralized model” that sidesteps Silvergate’s bad bets on BTC-backed loans. “BLINC funds are 1:1, unleveraged, un-rehypothecated, always precisely 1:1 with safeguarded funds.”

For Landsberg-Sadie’s sake, we hope BCB’s customer vetting is better than Silvergate/Signature because anything involving USD transactions with crypto firms is going to be put under a U.S. regulatory microscope.

‘Un-unbank’ yourself

Then again, why should digital currency exchanges bother with third-party banks when they could just launch their own? Recall that way back in September 2020; the Kraken exchange received a charter from the state of Wyoming to launch Kraken Financial, a ‘Special Purpose Depositary Institution’ (SPDI), which swiftly rebranded as Kraken Bank.

Precious little public progress was made toward this bank actually opening its digital doors, and Kraken Bank’s official website still states a planned ‘phased launch in 2022.’ But this week, Kraken’s chief legal officer Marco Santori told The Block that “Kraken Bank is very much on track to launch very soon.”

Santori said launching a de novo bank is a “massively parallel process,” and part of the reason it’s taking so long is because Kraken “is not super interested in launching a one-state bank, and then a two-state bank… we want to be able to launch with the most impact we can.”

Kraken Bank’s arrival took on new urgency last week when Kraken informed its non-corporate customers that Signature was halting all transactions with the exchange by the end of March. Neither Kraken nor Signature offered specifics on why Kraken was getting the boot, but it fits with Signature’s increased skittishness over the crypto-related business.

Not that Kraken didn’t give banks other concerns to think about. In 2019, Kraken founder Jesse Powell effectively admitted to committing bank fraud to ensure Kraken could meet payroll during its formative years. This February, Kraken paid a $30 million penalty and agreed to halt its U.S. customer staking programs after the SEC determined the exchange was dealing with unregistered securities.

Santori added with some resignation that the crypto sector was “returning to an era where banks are very cautious about what accounts they open … what goes around, comes around.” You know, we may have found crypto’s new motto. Well, that or…

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