The U.S. banking regulators have warned that cryptocurrency transactions could expose financial institutions to various risks, such as fraud and scams.
In a statement released on Tuesday, the regulators noted that the past year had seen significant volatility in the cryptocurrency market. They also said that there are various vulnerabilities in the sector.
The warning comes just weeks after the collapse of FTX, which previously was one of the biggest crypto-asset trading platforms. After the FTX bankruptcy, it was clearer than ever that the crypto-asset trading industry had been exposed to interconnected risks, poor risk management and outright fraud.
As for banks, the rapid emergence and growth of cryptocurrencies led to the formation of new partnerships between financial firms and investors. Executives from banks said they needed more guidance from regulators.
The regulators' statement indicated that they are still assessing how they can allow banks to accept cryptocurrencies while complying with their various anti-money laundering and consumer protection mandates.
The officials noted that holding or issuing cryptocurrencies on decentralized networks is generally considered inconsistent and unlikely to meet the standards of sound banking practices. This could affect the operations of several financial firms that have been providing crypto services to their customers.
"Based on the agencies' current understanding and experience to date, the agencies believe that issuing or holding as principal crypto-assets that are issued, stored, or transferred on an open, public, and/or decentralized network, or similar system is highly likely to be inconsistent with safe and sound banking practices," said the regulators.
In response, the Office of the Comptroller of the Currency (OCC) and the Federal Reserve said that banks must first get approval from their regulators before they can start engaging in certain crypto-focused activities.
According to the regulators, they are monitoring the activities of banks that are potentially exposed to the risks associated with the crypto-asset market. They are also reviewing proposals from financial institutions to participate in the industry.
The regulators also noted that they have significant concerns about the safety and soundness of financial institutions, mainly focused on the crypto-asset trading industry. However, they are working with other regulators to address the issues related to the industry.
Prior warning for accepting crypto deposits
In October last year, Michael Barr, a vice chair of the Federal Reserve, said that banks should be aware that they might face liquidity risks due to their interactions with other financial firms involved in the cryptocurrency industry.
Barr said that the Fed and other regulators were working to highlight the risks banks might face when they start accepting cryptocurrency deposits. These risks include the possibility of experiencing deposit volatility linked to the price movements of the broader market.
The vice chair also said that the volatility in the crypto-asset markets had revealed the extent of interconnectedness and centralization among the companies operating in this sector, increasing the stress levels in the financial system.
"The recent volatility in crypto markets has demonstrated the extent of centralization and interconnectedness among crypto-asset companies, which contributes to amplified stress," Barr said. "While banks were not directly exposed to losses from these events, these episodes have highlighted potential risks for banking organizations."
During a speech at DC Fintech Week 2022, Barr said that the regulators' actions weren't intended to discourage financial institutions from providing services to crypto companies. They merely wanted to ensure that the risks associated with these activities were adequately mitigated.
His speech was his first comprehensive address on the topic since becoming the Fed's top regulatory official in July. Barr said that the regulators should balance the need to support innovation with the protection of consumers.