Cryptocurrency is here to stay. As Wall Street gets involved, we look at some of the factors community banks should consider before they dive into the world of digital currencies.
By Katie Kuehner-Hebert
Are your customers starting to ask about products and services involving cryptocurrency? If so, or even if you’re just in research mode, be prepared to navigate the ever-changing cryptocurrency landscape to assess when, how or even if to dive into crypto.
of people would be interested in buying bitcoin from their bank if the service were available
As of Q3 2022, it’s estimated that about 46 million Americans—approximately 14% of the U.S. population—own cryptoassets, according to Ron Quaranta, founder and chairman of the Wall Street Blockchain Alliance in New York City.
“Now is the time to engage in the education process internally, as well as to begin to scope out what clients may look for in the future,” Quaranta says. “What happens for those clients who want to be paid in cryptoassets or whose businesses accept crypto for payments?”
Gary Smith, partner-in-charge of financial services at Eide Bailly LLP in Phoenix, adds, “Having a focus on understanding innovation and its impact on clients’ needs will be critical to the future success of all banking and financial services.”
To get you started, here are five things to know about cryptocurrency today.
First, some definitions
Also known as digital assets, digital currency, virtual currency and even digital money, cryptocurrency refers to a way to store and exchange value electronically. The “crypto” prefix refers to advanced mathematical codes used to store and transmit transactions in a secure format. Market demand and limited supply influence the price of digital currencies, making them volatile and highly speculative. While bitcoin (BTC) remains the most recognizable digital asset, other popular cryptocurrencies in the U.S. include ethereum (ETH), Tether (USDT), Ripple (XRT) and Litecoin (LTC).
The backbone of some forms of cryptocurrency, like bitcoin, is the blockchain. At its most basic level, blockchain refers to the “blocks” that get added to the “chain” of digital records (akin to a database). The chains provide a continuing list of records with data that can only be added; once validated, the information cannot be deleted or altered. The blockchain is a type of distributed ledger technology.
Distributed Ledger Technology (DLT)
Although a blockchain is a form of distributed ledger technology, distributed ledgers do not need to be in a chain like the blockchain. Put simply, a distributed ledger is a shared database that is spread across different computers or “nodes.” A distinguishing feature of DLT is it often restricts who can use, access and operate as a node on the network. This “permissioned” model has become more popular with banks.
Pegged to a fiat currency like the U.S. dollar, a basket of currencies or gold, stablecoins offer a less volatile form of cryptocurrency. Tether is the biggest stablecoin that is backed by the price of national currencies like the dollar, the euro or the Japanese yen.
Central Bank Digital Currency (CBDC)
A central bank digital currency is a digital form of a fiat currency that is issued and regulated by a monetary authority of a country or region. In the U.S., this also has been coined the “digital dollar.”
This is an edited excerpt from a Main Street Matters article. Read the full piece here »
If you’d like to understand even more about cryptocurrency, ICBA released a series of webinars on the topic last year. Find the first in the series here »
1. What is cryptocurrency?
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Cryptocurrencies are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.
“While bitcoin is the largest cryptocurrency by market capitalization, it’s important to remember that today there are more than 20,000 different cryptoassets trading around the world across more than 500 different exchanges, with a global market cap of more than $1 trillion,” Quaranta says. Within these assets there are different types of tokens, including tokens engaged in decentralized finance, or DeFi, and NFTs (see sidebar, below). (DeFi uses blockchain technology to enable financial transactions, such as peer-to-peer payments, without an intermediary, such as banks.)
2. Are stablecoins actually stable?
The collapse of TerraUSD (UST) in June, once the third largest stablecoin, roiled the cryptocurrency world, says Brian Laverdure, ICBA’s vice president of payments and technology policy.
Stablecoins are used to acquire other cryptoassets through crypto exchanges; in fact, nearly all digital asset trading involves a stablecoin, Laverdure says. As recently as the beginning of May, the stablecoin market reached more than $180 billion in circulation. Those stablecoins supported the entire crypto ecosystem, which was valued at approximately $1.75 trillion.
In April, acting comptroller of the currency Michael Hsu described this relationship as “an upside-down pyramid, with $2 trillion worth of crypto resting on roughly $180 billion of stablecoins.”
“Hsu cautioned that problems with stablecoins could destabilize the larger crypto economy and create ‘outsized losses for ordinary people owning crypto … potentially leading to a host of other knock-on effects,’” Laverdure says. “[His] predictions soon proved to be true when users of TerraUSD lost faith in the stablecoin and its network, which contributed to a significant decline in the overall crypto market.”
On May 7, an unknown user traded $85 million in UST for another stablecoin, USD Coin (USDC), on cryptocurrency exchange Curve Finance, he says. This swap was enough to overwhelm the mechanisms designed to maintain stability in the system and led to UST losing its peg with the dollar. This precipitated a run, because, importantly, there is no insurance to protect consumers if a crypto entity fails.
“In a matter of hours, UST experienced a precipitous decline in its value as others rushed to remove their assets from Curve, plunging from $1 to 76 cents,” Laverdure says. “The descent has deepened, and TerraUSD is now valued at mere pennies.”
The Terra sell-off quickly spread to other stablecoins. USDX, with a market cap of nearly $200 million prior to the crash, failed because it had UST as part of its collateral reserves, he says. So, when the value of UST toppled, so too did the value of USDX (not to be confused with the other USDX, the U.S. Dollar Index).
“As the dust from TerraUSD’s collapse settles and the industry takes stock of the causes, policymakers and market stakeholders are focused on what the failure means for the future of stablecoins,” Laverdure says. “In the immediate future, the total supply of stablecoins will likely be somewhat limited due to decreased crypto trading.”
3. Is cryptocurrency regulated?
Over the past several years, the U.S. Securities and Exchange Commission (SEC) has taken a strong enforcement stance against cryptoassets. “The SEC considers most, if not all, cryptoassets to be securities, falling under the purview of existing securities law,” Quaranta says. “This presents an entirely new series of challenges for cryptoasset proponents and all those who launch tokens within the cryptoasset industry.”
Notably, the SEC recently sanctioned token offerings on one of the major U.S. crypto exchanges, claiming that nine specific tokens were securities that were illegally sold as part of an insider trading case.
In addition to this, other regulatory agencies, including the Commodity Futures Trading Commission, the Internal Revenue Service, the Office of the Comptroller of the Currency and more have weighed in on the challenges, risks and responsibility for those participating in cryptoassets, “causing confusion along the way,” Quaranta says.
Over the next year, there will be a continuing high level of interest and scrutiny by regulators and policymakers, Laverdure says, but as to what exactly is going to happen, “much of that remains uncertain.”
4. Should community banks get involved in cryptocurrency?
When Chris Miller, director in the channels practice at Cornerstone Advisors in Scottsdale, Ariz., and his team talk to community bankers who want to get into cryptocurrency “full force,” he typically asks the question, “Why and how do you want to do it?”
“If the bank doesn’t have an investment arm, then getting into cryptocurrency is probably not the place to start,” he says. “But if the bank already has a wealth advisory division that handles investments, then it’s more feasible to offer cryptocurrency.”
Miller and his team recommend a four-pronged strategy, starting with educating board directors on the basics of cryptocurrency. Then, if the bank is interested in offering cryptoassets as investments, the team educates the board on potential digital banking partners, like NYDIG, that enable the buying, selling and holding of cryptocurrency on behalf of the bank’s customers and gives the bank an opportunity to share in the revenue of those transactions.
Next, Miller and his team discuss crypto payments—enabling the buying and selling of goods and services with cryptocurrency held at the institution.
“However, if a person is going to purchase things with a cryptocurrency debit card, they almost need a degree in statistics to determine the tax implications,” Miller says. “The SEC currently deems cryptocurrency as a security, so if someone uses cryptocurrency to purchase something, this is where that statistics degree will be required to understand the tax implications of this transaction.”
Banks could also offer crypto rewards. Instead of cash back on debit or credit card purchases, they could offer crypto back, he says.
Likely a “far off” idea that would require most community banks to gain more knowledge, the fourth prong would be lending against cryptoassets, somewhat similar to what banks now do for stocks and CD-backed loans.
“For a bank to feel comfortable making a $50,000 loan, they might need $500,000 in the borrower’s cryptocurrency account to back that,” Miller says. “Some institutions are doing that now, but it’s a very risky position to be in with the current market.”
Quaranta believes it’s an opportunity community banks should take seriously. “Community banks need to understand their client base and the amount of transaction volume and fee income that could potentially be missed by not enabling crypto purchases within the institution,” he says.
5. Is cryptocurrency worth the risk for community banks?
“There’s still regulatory uncertainty,” says Laverdure. “We don’t have harmonization on how community banks can offer crypto. They really need clear guidance about what is permissible and what is not. Beyond that, community banks are really in the best position to determine what are the best products for their needs and their customers’ needs. It’s a choice each community bank needs to make for itself.”
Community bankers continue to learn and stay on top of what’s new. “This is a space that moves so quickly that it’s absolutely essential to stay on top of the latest information,” he says.
“That’s where an organization like ICBA really shines through,” Laverdure says. “Bankers don’t have to go out and gather all of this information themselves—that’s what ICBA is here for. When you see communication from ICBA about these things, take the time to read it. That’s the best way to make sense of this rapidly moving space.”
ICBA’s crypto advocacy initiatives
In August, ICBA responded to the Treasury Department’s request for comments on how regulators can ensure “responsible development” of digital assets. In its letter, ICBA listed critical areas for the Treasury to consider, including:
- National security and implementing anti-crime measures should be the primary drivers of cryptocurrency policymaking and regulation.
- Agencies should collaborate to establish a clear regulatory framework for digital assets.
- Stablecoin issuance should be limited to insured depository institutions to address risks to financial stability, consumer protection and national security.
- Policymakers should prevent unregulated entities from issuing stablecoins and maintain the separation of banking and commerce to prevent a Big Tech stablecoin monopoly.
- Regulators should move swiftly on a comprehensive framework to address the shadow banking activities of unregulated platforms.
- ICBA opposes a central bank digital currency (CBDC), which would introduce risks without providing benefits to households, businesses and the overall economy.
Where do NFTs come into this—and what are they?
Non-fungible tokens, or NFTs, are cryptoasset-based tokens that cannot be replicated and are hence deemed “digitally scarce,” says Ron Quaranta, founder and chairman of the Wall Street Blockchain Alliance in New York City.
“To use a comparison, in a technical sense, every bitcoin is interchangeable for any other bitcoin,” he says. “In the NFT world, this is not the case. Indeed, each NFT in and of itself is a unique digital entity that leverages cryptography and peer-to-peer capabilities to show unique digital ownership and scarcity.”
NFTs started with digital art, most notably the “Board Ape Yacht Club” collection of digital art, as well as the auction of an NFT by internet-famous artist Beeple, which sold for $69 million at the height of the NFT boom in early 2021, he says.
“While these digital representations of unique value are important, it’s worth remembering that NFTs also represent an evolution of cryptoassets and blockchain technology,” Quaranta says. “The strategic NFT discussions today focus on everything from cryptoassets that are unique, scarce and have value applicable in the metaverse, for example, to the use of NFTs for real-world assets.”
For example, several projects are currently underway to embed physical real estate, titles and deeds to blockchain technology using NFTs. “In the future, NFTs will be a core component of how people and organizations exchange value across the global economic landscape,” Quaranta says. “It’s important to spend time now to understand what NFTs mean for the future and understand how they will impact your clients and your business.”
Katie Kuehner-Hebert is a writer in California.