Fitch Says Lack of Crypto Regulation Limits Further U.S. Bank Participation

The lack of a federal regulatory framework will likely limit U.S. bank participation in digital assets and the blockchain in the near-term Fitch Ratings says. U.S. banks have generally taken an “asset-light approach to digital assets”. This includes offering custody and collateral settlement via blockchain networks and issuing stable coin-based payment solutions. BNY Mellon recently began accepting bitcoin and ether from customers after receiving approval by the New York Department of Financial Services (NYDFS).

For banks it’s about security, customers and fees for the most part. The asset light approach avoids finalized prudential requirements that will result in punitive capital treatments for on-balance sheet exposures.

Growing tokenization of assets and the use of private distributed ledger technologies (blockchains) may enable fee-earning opportunities while reducing the transaction costs of intermediaries and accelerating the time to settlement for less liquid asset classes. Depending on the ultimate form of potential federal regulation, stable coins could allow for fractional reserving similar to deposits, which could create more profitable opportunities for stable coin issuers than if full reserving were required.

BNY Mellon is the first U.S. bank to store digital assets and traditional investments on the same custody and accounting platforms after receiving approval by the New York Department of Financial Services (NYDFS).

There is also Global Risks to Consider

Fitch cautions that “banks will likely tread cautiously until there is a comprehensive and ideally globally-coordinated regulatory framework given heightened fraud risk, cybersecurity concerns, and operational risks, as evidenced by several widely publicized crypto market failures such Celsius, Voyager, and algorithmic stable coin Terra/Luna.”

It is important to grasp that these risks are in addition to traditional risks lenders, bankers and participants face. These include market, regulatory, liquidity and counterparty risks. These would be in addition to digital asset participants but are exacerbated by extreme price volatility. The volatility until recently has been extreme in cryptocurrencies.

The relative nascence of the asset class creates additional uncertainties that are difficult to assess under a traditional risk framework.

Digital Market risks to be addressed by regulation include:

  • Correlation risks and hedge effectiveness
  • Risks from overleveraged transactions that can amplify losses across the ecosystem.
  • Investor and consumer protections and disclosures
  • How to counter the pervasiveness of fraud and potential for market manipulation in light of recent digital asset failures and bankruptcies.

Outstanding legal and accounting uncertainties include:

  • Reserving and auditing requirements for assets backing stable coins
  • Crypto asset classification and accounting treatment,
  • Segregation of digital assets in bankruptcy for custodians
  • Asset/liability measurement
  • Regulatory capital and financial disclosure requirements

Increased visibility from regulation and the accounting classification of digital assets as securities could accelerate the growth of digital assets by attracting more investors.

The tentative decision on Oct. 12 by the U.S. Financial Accounting Standards Board’s (FASB) that would permit the use of fair value accounting for crypto holdings could also result in wider institutional adoption of digital assets.

The previous accounting treatment of classifying stable coins as intangible assets required firms to mark them on their balance sheets at their lowest price during a given reporting period, without the ability to re-mark the values up should the price increase.

Fitch notes that the NYDFS has been at the forefront of U.S. regulation on digital assets through its Bitlicense. They have also given guidance for stable coin issuers operating in the state. A comprehensive legislative framework for digital assets at the federal level will likely need to be initiated through Congress, which is not likely happening anytime soon.

Source: Fitch

From the TradersCommunity Research Desk