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White House on Crypto Risks; Custodia Bank Update; UK Treasury Crypto Report

The White House Publishes a Letter Addressing Cryptocurrency Risks

What happened?

On January 27, the White House published a letter describing the administration’s strategy to mitigate cryptocurrency-related risks. The letter cites the collapses of the TerraUSD stablecoin and FTX in its critique of the cryptocurrency sector to evidence the industry’s lack of risk controls and poor cybersecurity.

The letter emphasizes the administration’s focus on preventing cryptocurrencies from affecting broader financial stability and suggests Congress follow steps outlined in the Financial Stability Oversight Council’s (FSOC) report from last year.

Moreover, the letter urges Congress to devise measures to prevent the misuse of customers’ assets by cryptocurrency companies and to strengthen their transparency and disclosure requirements. It also proposes that Congress increase penalties for breaking illicit-finance rules.

Lastly, the letter warns Congress that it would be a mistake to adopt legislation that “deepens the ties between cryptocurrencies and the broader financial system.

What does this mean?

On the bright side, the White House statement appears mindful that the failures that made 2022 a tough year for crypto should be attributed to centralized entities and do not represent the self-custody and peer-to-peer crypto ecosystem.

Last year’s collapses have motivated regulatory action in Washington, and we hope that energy is channeled into developing smart and focused policy responses. DeFi solves many of the problems mentioned in the letter, including the lack of transparency and the possible misuse of customers’ funds. That is why it is vital that lawmakers differentiate between centralized companies and decentralized protocols and adopt new regulations accordingly.

Fed Denies Stablecoin Bank’s Application

What happened?

Last week, the Federal Reserve Board of Governors unanimously rejected digital asset-focused Custodia Bank’s 27-month effort to become a member of the Federal Reserve System, which would have allowed Custodia, a state chartered bank, the same access as traditional banks to a Fed master account and the ability to offer banking services in all states.

In their press release, the Board of Governors explained that Custodia’s “novel business model and proposed focus on [digital] assets presented significant safety and soundness risks.”

Further, it found that “Custodia’s risk management framework was insufficient to address concerns regarding the heightened risks associated with its proposed crypto activities, including its ability to mitigate money laundering and terrorism financing risks.”

In a statement following the press release, Custodia CEO, Caitilin Long said the following:

“We’re the ones coming through the front door, asking for permission rather than forgiveness. That’s what regulators say they want, but their actions prove otherwise… The Fed has historically said in governor speeches that they want to level the playing field for innovators and incumbents… Custodia actively sought federal regulation, going above and beyond all requirements that apply to traditional banks. The Board’s denial is unfortunate but consistent with the concerns that Custodia has raised about the Federal Reserve’s handling of its applications, an issue we will continue to litigate.”

What does this mean?

Federal regulators’ broad refusal to bring centralized service providers in the crypto space into the regulatory perimeter has created perverse incentives and harmed consumers. With a few welcome exceptions (especially in law enforcement), many federal regulators over the last decade have adopted a “hold one’s breath and hope this all goes away” regulatory approach to crypto.

But time has shown crypto is here to stay, and US consumers will continue to demand crypto-related services like those Custodia hoped to offer in a regulated way. By refusing to regulate, federal agencies force US consumers to access those services from offshore businesses (like FTX) or businesses not subject to appropriate regulation will continue to lead to suboptimal outcomes and consumer harm. This approach also emboldens bad actors while, to Long’s point, punishing industry participants committed to “doing it the right way.”

UK Treasury Releases Crypto Report

What happened?

Early this week, the United Kingdom’s HM Treasury released a report entitled “Future Financial Services Regulatory Regime for Cryptoassets,” which seeks to provide a pathway toward a clear regulatory framework for the ecosystem.

The report expressed that “[b]y capitalizing on the potential benefits offered by crypto, we can strengthen our position as a world-leader in FinTech, unlock growth and boost innovation.”

Further, the report found that the collapse of firms like FTX illuminated the need for “clear, effective, timely regulation and proactive engagement with [the] industry” in order to “create the conditions for cryptoasset service providers to thrive in the UK, and give people and businesses the confidence to invest” and benefit from the efficiencies these technologies provide.

The HM Treasury’s stated objective “is to establish a proportionate, clear regulatory framework which enables firms to innovate at pace, while maintaining financial stability and clear regulatory standards,” which “includes a proposal to bring centralized cryptoasset exchanges into financial services regulation …, as well as other activities like custody and lending.”

However, the HM Treasury also expressed in the report that the regulatory framework for CeFi is applicable to any “cryptoasset activities regardless of the underlying technology, infrastructure, or government mechanisms.” But acknowledges that the framework may differ due to the “rapidly evolving nature of the sector,” and that the UK is not equipped to “frontrun a prescriptive framework.”

What does this mean?

First, it's important to note that the report focuses primarily on CeFi crypto institutions and mirrors the approach the EU took with MiCA, which also focused primarily on bringing crypto firms under the same umbrella as other financial institutions.

Nonetheless, it is encouraging to see a jurisdiction as influential as the United Kingdom recognize the potential benefits and efficiencies the underlying technology can provide and commit to engaging with the space in order to develop the most informed and reasonable framework.

Although it is mentioned in the report that the HM Treasury believes CeFi regulatory framework should apply across the sector, they recognize it may not be so straightforward to regulate such novel technology.

We will continue to monitor the proposals and recommendations that follow from this report.

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