How should community banks coexist with cryptocurrencies?

The salience of digital currencies is clear: Last year, the market capitalization of all cryptocurrencies reached a record $2 trillion, and there are almost 10,000 different cryptocurrencies. 

Though cryptocurrencies could be seen as a threat to traditional finance — they neither need an intermediary nor are they tied to a centralized government, bank or regulatory agency — consumers still indicate a strong desire for a bank to be involved: A survey conducted in early 2021 by bitcoin company NYDIG involving nearly 2,200 U.S. consumers showed that more than 80 percent of bitcoin holders would move their cryptocurrencies to a bank if it had secure bitcoin storage. More than 70 percent of bitcoin holders said they would switch their primary bank to a bank that offered bitcoin-related products as well as regular bank products.

Community bankers worrying that demand for cryptocurrencies might eclipse demand for traditional bank products will be well-served to remember that consumers attracted to decentralized finance still yearn for the security offered by a bank. 

Yet one thing is clear: The crypto surge is real.

A crowded field

Instead of relying on centralized intermediaries, trust in crypto transactions is placed in a blockchain code — a system where a record of a transaction is made and maintained across several computers that are linked in a peer-to-peer network, explains Marissa A. Scicchitano, a CPA with Wolf & Co, P.C. 

Community banks are starting to warm to cryptocurrencies. In 2021, Tulsa, Okla.-based community financial institution Vast Bank became the first nationally-chartered, FDIC-insured bank to allow customers to buy, sell and hold cryptocurrencies through its user interface. The program is being rolled out through an institutional policy with the cryptocurrency exchange platform Coinbase, and includes mobile banking apps available on Google Pay and Apple Apps. 

The Vast Bank website advertises 24/7 service, interest-bearing checking accounts, no transfer delays, minimal trading fees, debit cards with free nationwide ATMs, and the ability to pay bills, deposit checks and other expenses. Currently, Vast Bank offers a hot wallet allowing a cryptocurrency owner to receive and send tokens through a prime brokerage. Users can move those tokens to cold storage — offline to prevent hackers from accessing their holdings via traditional means. Customers cannot pay people who are not affiliated with the bank through cryptocurrency, but some companies already offer that service with a prepaid card.

There are several major platforms in the crypto market: Ethereum, Cardano, Solana, Polygon and Chainlink, to name a few. Some of the wealthiest individuals and corporations are throwing their weight behind the industry: 

  • Tweets last year from Tesla CEO Elon Musk led to a spike in the price of the cryptocurrency Dogecoin, an open source, peer-to-peer digital currency. 
  • Meta (formerly Facebook), one of the largest companies in the world, has joined more than two-dozen other companies in proposing Libra, a blockchain-based payment system, which would be implemented as a cryptocurrency. 
  • Mastercard announced last year that millions of merchants on its payment network could soon use crypto — Bitcoin wallets, credit and debit cards that earn crypto rewards and allow digital assets to be spent — through the crypto firm Bakkt. 
  • JPMorgan Chase has taken on Coinbase and Gemini cryptocurrency exchanges as banking customers. 
  • Fidelity Digital Assets is creating a crypto fund. 
  • PayPal is allowing cryptocurrency transactions on its network. 
  • Also, asset-backed cryptocurrency Bitcoin Latinum is partnering with the Arizona-based service company OSO ATM to install 100,000 Bitcoin and Bitcoin Latinum ATMs (LTNMs) across the United States. 

Crypto ATMs are proving to be a worldwide presence, as evidenced by comments from Oos Arikat, chief operating officer at OSO ATM: “In El Salvador for instance, bitcoin ATMs allow people to transact in the crypto token or convert it to fiat. Bitcoin Latinum aims to bring the ease of using cryptocurrencies in the United States.” 

El Salvador in September became the first country to adopt Bitcoin as legal tender and is planning for the first “Bitcoin City.” Nayib Bukele, El Salvador’s president, is betting on harnessing the cryptocurrency to fuel investment in that country. 

There has also been a large increase in the use of stablecoins — a cryptocurrency designed to have a relatively stable price. Last October, former FDIC Chair Jelena McWilliams said that several firms are exploring the potential for stablecoins to serve as a mechanism for retail payments. Some banks have established limited payment networks for commercial customers to transfer funds using tokens in almost real time.

“Stablecoins can offer many potential benefits … a faster, cheaper, more efficient mechanism for making payments than legacy systems … ‘programmable’ payments that happen automatically based on the occurrence of a specified event, which could lead to better management of debt repayment,” McWilliams said.

Despite the meteoric growth, community bankers should be aware that the industry is not always protecting investors. Cryptocurrencies have sometimes lost market capitalization and been associated with criminal acts, such as the Twitter hack of July 2020, when 130 high-profile Twitter accounts were compromised.

Decentralized cryptocurrency markets are rife with “fraud, scams and abuses,” often used by criminals to skirt laws and engage in money laundering, extortion and ransomware, said U.S. Securities and Exchange Commission Chair Gary Gensler last August. Though he admits there are good actors in the marketplace, investors are not receiving sufficient information to protect themselves against the possibility of being victimized. Gensler called on Congress to allow for more SEC staffing to address such crypto issues, noting that even doubling or tripling the current employment numbers would still not be sufficient to address the burgeoning industry. 

Speculation is rampant: A survey published in early November by online polling app Civic Science revealed that 4 percent of 6,741 respondents had resigned from a job due to financial gains from the crypto market over the past year. The majority of those who quit left jobs where they had made approximately $50,000 or less per year. Nearly 30 percent of the nearly 17,700 people who responded to the question of why they chose to invest in crypto said it was more appealing as a long-term growth investment. Twenty-three percent were in it for short-term gains, and 11 percent said it was a cushion against inflation. 

Regulators play catch-up

Though the industry offers promise, it still lacks regulation and legal clarity in crucial areas. The Wisconsin Department of Financial Institutions cautioned Wisconsin investors last August about the risks associated with interest-bearing crypto-asset and cryptocurrency accounts. “Investors should be cautious and skeptical of investment offers that sound ‘too good to be true’ or that offer guaranteed high returns with little risk. All investments carry the risk that some or all of the invested funds could be lost. High interest rates could often indicate high risks,” said Wisconsin DFI Secretary Kathy Blumenfeld. 

When an investor makes a deposit, they usually exchange their cryptocurrency for a promise by the issuing company or borrower for a return of the same amount of cryptocurrency plus interest whenever the investor requests a withdrawal of the invested funds or at the end of a fixed term. Cryptocurrency accounts can appear to be similar to savings accounts offered by banks and credit unions, except these interest-bearing accounts are usually much riskier. Deposits made by investors are only denominated in crypto. Neither the FDIC nor any other governmental agency insures deposits in interest-bearing crypto accounts. According to the DFI, crypto markets do not have access to the liquidity facilities that exist in the regulated banking system to protect depositors. 

In a letter to Congress last year, Matthew A. Daigler, vice president and senior counsel at the American Bankers Association, said determining the legal status of cryptocurrencies is challenging because of unclear regulations on permissible bank digital asset activity and the lack of consistent classification for digital assets. “The risk profiles of cryptocurrencies like Bitcoin are different from the risk profiles of stablecoins, and therefore their regulatory treatment should be tailored to correspond to their respective riskiness,” he said.

Bankers should expect the crypto industry to face more regulations in the coming years. A year ago, the Office of the Comptroller of the Currency announced that national banks and federal savings associations could use public blockchains and stablecoins to perform payment activities, placing blockchain networks in the same category of SWIFT, ACH and FedWire. Six months later, the OCC stated that banks and savings associations could provide crypto custody services for customers. To do so, OCC-regulated institutions must show that they have adequate controls in place before engaging in certain cryptocurrency, distributed ledger and stablecoin activities. 

Despite those challenges, crypto experts at Wolf & Co., and the ABA agree that banks must embrace crypto. Banks “are ideally suited to perform custody services in connection with digital assets, because they have the legal and compliance systems in place to address applicable anti-money laundering requirements, as well as address cybersecurity and risk management issues,” the ABA stated. 

By embracing blockchain, banks could streamline shared data on customers with each other, loan officers and other institutions, allowing for quick reviews of customers to promptly identify potential illicit activity. Banks can also onboard less experienced individual investors by developing tools to facilitate the adoption of crypto by their customers or offering interest-bearing crypto accounts.