Financial Planning Dentist

Let Bitcoin Fail

Before it becomes, too big to fail also. The Federal Reserve and Treasury need to establish a better policy regarding their role and behavior when Bitcoin fails. Continued ‘bailout’ for speculative players in the market has a critical and damning effect on the rest of us. Taxpayers have already lived through the negative economic and social impacts of watching banks and speculators who took on unjustified risks get reimbursed for their recklessness once this century. Watching banks stash and store cryptocurrencies under the same speculative bubble is foreboding. The U.S. simply cannot afford to bail out speculators who have driven the market of Bitcoin past $1T with no concern for uninsured assets.

It is already bad enough that U.S. financial regulators have proven to be ill-equipped to enforce current AML and BSA policies in the wake of crypto adoptions. Financial institutions’ exposure to the crypto-asset industry is affecting their bank’s anti-money laundering compliance and oversight and several years’ worth of infractions are piling up at some of the nation’s biggest banks. Additionally, several of the ‘online’ banks that are continuing to offer crypto-trading as part of their expanded services are doing so without the proper due diligence and vetting of their counterparties. Market regulators aren’t watching closely to see how financial institutions’ exposure to the crypto-asset industry is affecting their banks’ anti-money laundering and compliance. As the broader public becomes more interested in crypto assets, some bank customers are seeking ways to fund crypto trading. In this environment, banks need to assess how these activities are isolated from their current operations and be prepared to mitigate illicit finance risks emanating from these new assets. Additionally, the Fed and FDIC allowing high-risk speculative assets to be connected to U.S. currency is as irresponsible as the housing crisis demonstrated; and these Federal authorities need to make more clear that they will let this speculation fail or rise under its own power and that using taxpayers institutions to protect this asset is not in our best interest and a lesson in moral hazard that should eventually be learned.

Suspend FDIC insurance for all banks that continue to mask their crypto-speculation with support and protection of the Fed and the FDIC Now. 

Contagion is Spreading

As major U.S. Banks are getting swept up into the asset bubble they are taking our oversight and insurance institutions with them. In February the U.S. Office of the Comptroller of the Currency (OCC) issued a cease and desist order to New York-based Safra Bank. In the order, the OCC cited that “the bank gave accounts to money service businesses (MSBs) that facilitated crypto-asset trading” but that the bank did not “address the increased Bank Secrecy Act and Anti-Money Laundering (BSA/AML) risks associated with these accounts.” While the OCC has caught this bank, the ecosystem of back offering these ‘crypto trading accounts’ is outpacing the oversight of the banks and regulators. Simply put – the market is growing beyond our ability to control, and U.S. banks supported by the Federal Reserve are connected to this exposure.  

In the Safra Bank case, the bank allegedly did not have sufficient transaction monitoring systems in place in the onboarding process to confirm these new “digital asset customers” were legitimate and this caused its volume of domestic and international wires and ACH transfers to spike. 

Unfortunately, the OCC has yet to specify the crypto-asset-focused companies involved with Safra’s breach of the KYC ecosystem.  Though the San Francisco Open Exchange (SFOX), has allowed SFOX traders to maintain FDIC-insured cash accounts at the bank. This is general incompetence and complacency that is allowing the crypto asset bubble to contaminate the federally insured accounts at other banks.

Liquidity is Drying Up

The world’s largest cryptocurrency, bitcoin sits just below $60,000 today, as the total market cap of BTC is above $1.1 trillion. Despite the recent price jump, there is a major concern BTC holders and even non-speculators should be aware of. That is the liquidity of Bitcoin.

JP Morgan’s strategist Nikolaos Panigirtzoglou writes “the market liquidity in Bitcoin is significantly lower than S&P 500 and gold.” Panigirtzoglou adds that “even a small change in Bitcoin flows can have a large impact on the price of BTC.” The liquidity issue is driving up the speculative costs of bitcoin but should be a major concern for those that purport the BTC is some kind of store of capital.

Low liquidity will have a negative impact on the rash of new Bitcoin lending schemes that are proliferating in the market. Several new companies are offering interest on bitcoin deposits made possible by lending out those coins to speculative investors. As the underlying price of bitcoin rises out of control the borrowers become less and less likely to return the borrowed coin (almost an impossible default rate to handicap). These defaults, coupled with the lack of liquidity, will make it almost impossible for borrowers to cover. If this ‘bank run’ scenario were to play out in cash the Fed can step in to increase liquidity and control interest rates, and the FDIC can insure the lenders against defaults and make them whole. There is no such protection for Bitcoin lenders.  

Low Reputation Counter Parties

The crypto market has still yet to solve its illegal and illicit underbelly. While widespread adoption is making for more legitimate transactions, it is similarly eroding the capacity of regulators and compliance officers to confirm they are not transacting with corrupting counterparties. While making the ecosystem ‘bigger’ lowers the percentage of bad actors, it also increases their space to hide among legitimate actors. Criminals who keep their funds in cryptocurrency tend to launder funds through a small cluster of online services that exist outside of regulator authority. Essentially saying, banks and speculators are doing business with criminals (if done in dollars is criminal also) but because it’s done in crypto it is willfully existing outside the law.

Services like high-risk (low-reputation) crypto-exchange portals, online gambling platforms, cryptocurrency mixing services, and financial services that support cryptocurrency operations headquartered in high-risk jurisdictions are making a market for banks to buy cryptocurrencies including bitcoin sell the unmonitored coins back to criminals. Surely, creating a currency market and liquidity for criminals like sex and drug traffickers is as bad as the act itself. We can no longer claim deniability. In 2020 US exchanges sent $41.2 million directly to criminals.

The KYC ecosystem is fragile, and unfortunately only as strong as its weakest link. Banks and brokerages spend billions ensuring they are only dealing with reputable and honest actors while ignoring the fact that in 2020 one in three cryptocurrency transactions were with international counterparties with weak KYC standards. Criminal activity linked to online scams, ransomware attacks, terrorist funding, hacks, transactions linked to child abuse materials, and funds linked to payments made to dark web marketplaces offering illegal services like drugs, weapons, and stolen data is the most common among fraudulent actors. It is admittedly a small group of bad actors, that are just getting a more lucrative habitat to thrive in.

An Opportunity to Avoid a Mistake

This is an opportunity for officials and regulators to finally get in front of national financial crises and cut off the coordination that will pull low-risk, cash savers at banks into the rollercoaster of speculation in cryptocurrencies. It’s an opportunity for the nation to be proactive and protect the rank in file savers and taxpayers who simply cannot afford to be contaminated by this risk.

There is already a social and psychological contagion that cryptocurrency has established, there shouldn’t be a structural banking connection as well. Cut off speculative banks from accessing federal insurance programs now. 

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