U.S. Federal Reserve Opens Traditional Banking System to Crypto Banks
On Tuesday, the U.S. Federal Reserve instituted regulation allowing crypto banks to join the traditional banking structure. The Fed set up a three-tiered system for evaluating the risk level of each financial institution.
“The new guidelines provide a consistent and transparent process to evaluate requests for Federal Reserve accounts and access to payment services in order to support a safe, inclusive, and innovative payment system,” said Vice Chair Lael Brainard.
Recently crypto lenders such as Voyager and Celsius, which purported to operate like banks, have declared bankruptcy — leading to millions of users losing their investments. Now with Genesis clearly struggling, having laid off 20% of their workforce on Wednesday, it is clear that crypto lenders need a better regulatory framework that evaluates risk more effectively. While these guidelines are not legally binding, they lay the groundwork for a more established policy framework that will help move crypto banks into the future.
Background
This issue has been coming to a boil over the past year, with multiple developments pushing the Fed to release some documentation clarifying the regulatory environment for crypto banks. Here’s what’s happened:
- Senator Pat Toomey (R-PA) sent a letter for the Federal Reserve to find out why Reserve Trust, a small, politically-connected fintech company, was issued a master account, only to later have it revoked.
- Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) recently proposed a crypto bill that would entitle any “depositary institution with a state charter to an account at the Federal Reserve.”
- Caitlin Long, head of Custodia, a crypto bank domiciled in Wyoming, filed a lawsuit against the U.S. Federal Reserve Board of Governors for an ‘unlawful’ delay in the decision to approve a master account. According to the lawsuit, the Fed’s documents state that the decision for granting an account should be around 5 to 7 business days, but no more than one year. Custodia’s application has been pending for 19 months.
The Fed first proposed guidance like this last year, opening the process up to request-for-comments. Almost 300 companies responded, leading to a second round of feedback in early 2022.
What are the new guidelines?
The main purpose of these guidelines was to clarify a critical question for the crypto industry: who is allowed to have a master account?
A master account would allow crypto banks and other fintech organizations access to the Federal Reserve’s payments and services platform without having to partner with a traditional bank.
Under the guidance, a three-tier system will be implemented to evaluate different levels of risk for each institutional applicant. Tier 1 marks federally insured applicant institutions. Tier 2 applicants are not federally insured but are still “subject to prudential supervision by a federal banking agency.” Tier 3 consists of “novel charters,” including “cryptocurrency custody banks and their trade associations” that are “not federally insured and not subject to prudential supervision by a federal banking agency.”
There was only one direct reference to crypto in the whole document, which is quoted above, but has left plenty of room for crypto firms to maneuver into master account access. This is a positive moment for the crypto community. As indicated in the Fed guidelines, its board “does not believe that it is appropriate to categorically exclude all novel charters from access to accounts and services.”
That being said, gaining access to master accounts is unlikely to be as simple as it appears. Reserve banks have been instructed to integrate as much as possible, but that levels of due diligence and scrutiny will be substantially higher to firms with novel charters. Those firms with “undergo a more extensive review” than traditional firms under these guidelines.
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