Traditional Finance Moves Closer to Cryptofinance

As U.S. and international financial regulators debate how to regulate cryptocurrencies, financial institutions make business moves toward crypto legitimation.

State Street, the Boston-based custodian bank and second oldest in the U.S., announced the formation of a new digital asset unit, with a bitcoin notice on its home page. “We are striving to totally re-imagine and reinvent the way we do things. And if clients want to trade crypto, we’ll be able to support that,” says division head Nadine Chakar in an interview with American Banker‘s Penny Crosman.

“The most radical aspect of State Street’s digital currency strategy is its belief that decentralized financial markets are coming,” Crosman writes. “The reason is simple: Even amid the high-profile volatility in bitcoin, cryptocurrency investments rose 300% from February to April at the trust bank.”

Decentralized finance or DeFi is an emerging network of crypto-based FinTech firms that enable financial transactions through distributed ledger technologies. DeFi, too, got a nod from traditional financial types, as reported in The Defiant.

“The World Economic Forum, a bastion of the global establishment and ultra-exclusive club for heads of state, billionaires, and policymakers, is embracing DeFi. Well, sort of,” writes Owen Fernau. The article covers the WEF’s publication this week of “Decentralized Finance: (DeFi) Policy-Maker Toolkit.” The toolkit follows DeFi investigations published by other traditional finance organizations: the University of Pennsylvania’s Wharton School and ING Wholesale Banking.

Meanwhile, El Salvador last week approved bitcoin as legal currency. “El Salvador President Nayib Bukele tweeted that the “Bitcoin Law” has been approved by a “supermajority” in the El Salvadoran Congress on June 9, making the country the first in the world to formally adopt bitcoin as legal tender,” Blockworks reports.

It’s another example of the long-held belief that bitcoin will gain acceptance as a currency by developing nation states. El Salvador’s vote is “no surprise considering the region, long plagued by underdevelopment and volatile politics, has struggled to enfranchise its citizens in the global financial system, with too many households remaining unbanked,” The Defiant notes. Other Latin American nations are seeking to follow suit.

The U.S. is neither hot to follow nor disinterested, where the Federal Reserve is increasingly talking about its experiments with a digital dollar. “It could help improve financial inclusion, efficiency, and the safety of our financial system — if that digital public money is well-designed and efficiently executed, which are two very big ‘ifs,’ ” said Sen. Elizabeth Warren, D-Mass., who chairs the economic policy subcommittee.

The American Banker article that quotes Sen. Warren also notes that Fed Chair Jerome Powell “said in the video message that regardless of the Fed’s decision about developing a digital dollar, the Fed would “expect to play a leading role in developing international standards for CBDC.””

And the U.S. and international regulators weighed in this week on bitcoin and by extension other digital assets. In a pair of articles over the past month, the Financial Times covers a split in the U.S. regulatory outlook toward cryptocurrency. Typically, the debate is reported along party lines.

“US financial regulator warns against strict cryptocurrency rules” covers comments made this week by Securities and Exchange Commission Hester Peirce, a Republican, who told the FT:

“I am concerned that the initial reaction of a regulator is always to say ‘I want to grab hold of this and make it like the markets I already regulate’. I am not sure that’s going to be great for innovation.”

The FT notes that “her comments expose a split at the top of the SEC just as Gary Gensler, its chair, spearheads an effort to bring the fast-growing cryptocurrency market more in line with other types of financial assets.”

In an earlier article, the FT reported that “US regulators signal bigger role in cryptocurrencies market.” The article is based on an interview with Michael Hsu, acting director of the U.S. Office of the Comptroller of the Currency (OCC) and focuses on the need for cooperation among the many regulators of the U.S. financial system,

“The danger is that new and improved techniques give rise ‘to a large and less regulated shadow banking system’. Today, fintechs and technology platforms are devising payment processing tools that ‘bring great promise’, Hsu said, “but also risks’.”

For its part, the Bank of England issued its comments on stablecoin payments, Reuters reports. “The prospect of stablecoins as a means of payment and the emerging propositions of CBDC have generated a host of issues,” BoE Governor Andrew Bailey said. “It is essential that we ask the difficult and pertinent questions when it comes to the future of these new forms of digital money.”

International regulators are looking at the risks inherent in those difficult questions, and this week issues specific guidance on how financial institutions should treat them. In outlining the risks digital assets pose, the Basel Committee on Banking Supervision proposed that banks apply a 1,250% risk weight to their exposure to bitcoin and other cryptocurrencies. The proposal is open for comment until September 10.

This was reported as both a negative and a positive. After all, most assets require the backing of 8% to maybe 50% capital backing at U.S. financial institutions. The Basel committee recommended that bitcoin assets held by banks be backed 100%, dollar for dollar.

Bloomberg‘s “Money Stuff” columnist Matt Levine makes the case that the 1,250% backing recommended is a positive step forward for bitcoin and its acceptance in traditional mainstream finance. As he put it in his most recent column:

“Cocaine does not have a 1,250% risk weight; it has a ‘no no no this is not what banks do’ risk weight. Moving Bitcoin from ‘absolutely not, what on earth’ to 1,250% is a positive.”

– Collin Canright