Banking and Crypto: A Complicated Relationship
The crypto industry has been through a rough time in the last year. Lending companies and exchanges failing, stable coins collapsing, and most recently the failure of “crypto-friendly” banks including Silvergate Bank, Signature Bank, and Silicon Valley Bank.
I have worked in crypto for the last five years and have seen the tremendous growth of the industry. Back in 2018, it would take a bitcoin transaction about 10 minutes to clear on-chain whereas we are now seeing that issue solved via the lightning network, which can process approximately 1,000,000 transactions per second. Yet, one issue that existed back then persists today and that is the complicated relationship that crypto companies have with traditional banks.
As a compliance professional in the early days of crypto, I saw firsthand the difficulty crypto companies faced with respect to securing banking. Many banks did not offer any banking solutions to crypto companies nor were they keen to begin to offer those services. The bank(s) we did rely on, however, were Silvergate and Signature bank. Still, the relationship was a difficult one to establish and maintain because of the level of risk that banks associate with crypto businesses.
But what is it that really makes crypto businesses so risky from the perspective of the bank? Is it BSA/AML risk, consumer risk, financial risk or reputation risk? One could contemplate the idea that a risk associated with crypto is fear of the unknown. Traditional banks do not, typically, have either a good understanding of crypto or the technological means to trace transactions. This results in limited visibility to the activity of crypto companies. This is not the position a bank should be in given the significant amount of regulatory obligations that they are expected to meet.
What happens next is important
So what gives? How are banks supposed to keep in compliance with their current regulatory requirements and expand their portfolio to include crypto? I’m not defending banks here but I see the pressure they are under from regulatory authorities and think that the potential issue with this relationship stems from the two points mentioned earlier (lack of technical understanding and lack of technical means).
The banking failures of Signature and Silvergate specifically, can be attributed to lack of financial risk management. However, there is also something to be said about the role of regulators and crypto companies. Currently, banks function as an onramp/offramp solution - connecting crypto businesses to traditional finance. They are communicating with and between regulators and crypto companies, however, the message is either not being properly sent or properly received.
Well, what is the message? For crypto companies, the message is clear: implement proper compliance and risk management. We have seen regulators indirectly state as much in their joint statement earlier this year. However, it is also important for banks to put themselves in a position to be properly prepared to bank crypto companies by investing in crypto investigative tools like Chainalysis, TRM Labs, and Unit 21. They should properly educate their workforce and seek compliance professionals with crypto industry experience. This is easier said than done and without willingness from both sides, it is not likely to be successful.
Recently, we have seen an effort from Coinbase to push crypto-friendly legislation via their Coinbase435 campaign. In many ways, Coinbase leads the way for many crypto companies and start ups in efforts to push crypto forward. It is important for the crypto community to work together to avoid taking steps back. There needs to be greater sharing of information and a better line of communication within crypto and between crypto companies and banks. Lastly, it is important to remember that crypto is only one use case for blockchain and even though we have seen cases where crypto projects end up being scams, rug pulls, or pump-dump schemes, there are also projects that are legitimate. These legitimate projects and their companies need banking and that is not changing. Denying crypto companies banking will only push them to find ways around the rules by using front companies with business purposes outside of crypto to secure an account. This result is not helpful to banks and the larger U.S. financial system.