Wanted: A Prudential Framework for Crypto-Assets

Abstract

The collapse of cryptocurrency exchange FTX in November 2022 is the most significant moment in cryptocurrency history. While many commentors referred to FTX’s failure as “crypto’s Lehman moment,” the fallout was largely contained within the cryptocurrency ecosystem and there was minimal spillover into the traditional financial system. Limited interconnections between the crypto ecosystem and the traditional financial system is the principal reason FTX’s fallout was limited. This outcome is partially due to coordinated actions of federal bank regulators who each had outstanding guidance in place at the time of FTX’s failure expressing concerns over banks’ ability to engage in crypto-asset activities in a safe and sound manner and requiring banks to notify their appropriate regulator before engaging in such activity. While the banking agencies have wide latitude to prohibit any activity they consider incapable of being conducted in a safe and sound manner, it would be difficult to argue that all crypto-asset activities threaten safety and soundness. The question then is: where should bank regulators draw the line? This paper summarized the limited publicly available data on banks’ exposure to crypto-asset activities and offers several specific examples of how U.S. banks engage in crypto-asset activity. It then examines past guidance issued by U.S. bank regulators and explains why this guidance lacks sufficient detail to clarify the prudential requirements associated with the various crypto-related activities banks are engaged in. The article then assesses the adequacy of the Basel Committee on Banking Supervision’s final prudential standard for crypto-asset exposures, issued in December 2022, and finds that the standard fails to adequately address the unique risks various crypto-asset activities pose to banks. We conclude by offering recommendations U.S. bank regulators can quickly implement to dimension the scale of banks’ crypto-asset exposure and mitigate the associated risks.

Keywords: prudential regulation, cryptocurrency, banking law

JEL Classification: G01, G21, G28, K23