Thread by @nic__carter

Longer thread on the FDIC’s 2022-23 “pause letters” to banks regarding crypto-asset activities in 2022 and 2023. Strap in

So we all know that banks have been stymied from doing crypto stuff for years: regulators installed 15% deposit caps on fiat deposits from crypto firms, cutting off bank access for the whole industry; the SEC used SAB121 to stop banks custodying crypto; and the Fed effectively prohibited banks from doing stablecoin stuff. But maybe the worst and most brazen was the FDIC unilaterally barring banks from doing any crypto stuff at all…

So recently, Coinbase made FOIA requests to the FDIC regarding their guidance to banks on crypto matters. Last month, the FDIC published summaries of these letters, without saying what they said exactly, or which banks they were addressed to.
assets.ctfassets.net/c5bd0wqjc7v0/7…

The FDIC’s summary includes passages like: “the FDIC received the bank’s submission of information concerning a proposed new crypto-asset product, describes the nature of the product proposed by the bank, and that it is intended for bank customers. The letter further states that the FDIC has not yet made certain determinations about that type of activity, and asks that the bank pause all crypto asset-related activity. The letter states that the FDIC will provide notification when a determination of supervisory issues has been made.”

There are 30 such letters, all from 2022.

I set out to figure out what these letters pertained to. After thinking about it, I concluded that at least some, and probably most, of these letters were addressed to banks that had had sought to create a Bitcoin exposure product with NYDIG.

According to FDIC data, as of January 2023, the Agency was aware of 96 FDIC-supervised financial institutions that either had expressed interest or were engaged in crypto-related activities. Some of these activities included crypto-asset-custody services, deposit services, crypto-asset-collateralized lending, and facilitation of customer purchase and sale of crypto assets through a third party.

fdicoig.gov/sites/default/…

NYDIG’s program falls into the latter category. The idea was to use bank software providers like Fiserv or Computer Services Inc to give ordinary depositors access to Bitcoin buy/sell via their online or mobile banking portals. It was widely promoted in 2021/22 and was set to go live with 300 community banks in Q1/Q2 2022. The idea was that NYDIG would facilitate the brokerage and storage, and the customers would have an account with NYDIG. The interface would be their conventional online/mobile banking interface, and the community banks would pass along user credentials to NYDIG so users could open an account.
americanbanker.com/news/small-ban…

Importantly, the BTC would not be externally transferable in this setup. Keep in mind this wasn’t at all a risky or particularly novel product, you can get BTC access through many platforms and asset managers, like Fidelity, Coinbase, Robinhood etc. The only different thing was that it was facilitated by the community banks.

The community banks were thrilled about this, because they noticed that they were losing deposits to Coinbase. They were competing for deposits with crypto platforms. Additionally, the product offered the banks something very valuable – non-interest income. Banks are always looking to diversify their revenue sources and this was a potentially very valuable revenue stream.

Now, a huge caveat. I don’t currently know for absolute certain that the FDIC pause letters were sent to banks partnering up with NYDIG, but I am about 95% sure they were. It’s possible other banks were doing other crypto-related things at the time, and the 30+ pause letters were about those things. But the weight of evidence leads me to believe that at least some, and probably most, of these letters had to do with the NYDIG bitcoin product rollout.

As a brief aside, I’ll mention that the first bank publicly known to have integrated crypto buy/sell directly (way back in 2021), Vast Bank, was slapped with a consent order from the OCC in 2023, and was forced to stop offering crypto products. You could say, “every bank that sought to do crypto stuff had weak risk management and controls”. Or you could say, every bank that did it made themselves a target, and regulators found a pretext to harass the bank.

So the FDIC asks banks in 2022 to notify them if they are doing any crypto stuff. 96 banks say they are. The FDIC then sends these letters in 2022-23 to banks aiming to do “crypto-asset-custody services, deposit services, crypto-asset-collateralized lending, and facilitation of customer purchase and sale of crypto assets through a third party.” And the Bitcoin access product for these 300 community banks with NYDIG fails to launch. Not a peep is heard about it ever again.

And keep in mind, this isn’t even the main “Choke Point 2.0” stuff I’ve been complaining about. That’s a whole separate issue, namely installing these deposit caps pertaining to fiat deposits by crypto clients in US banks, limiting banks’ ability to serve crypto. And the kneecapping of pro-crypto banks Signature and Silvergate. These pause letters I’m talking about are an entirely other initiative by the FDIC to stop banks launching crypto products.

Now what was the FDIC’s justification for the pause letters? Well, the FDIC at that time hadn’t said much about what they thought the risks to banks were from crypto. In the letters, the justification for the pause was to “assess potential safety and soundness and consumer protection risks that may be faced by the bank, specifically, and the banking industry generally”.

Later on, in the 2023 Joint Statement, the FDIC would enumerate more specific risks, but they hadn’t published that yet. In their April 2022 “notification of engaging in crypto-related activities”, the FDIC simply said “Crypto–related activities may pose significant safety and soundness risks as well as financial stability concerns.” Ok.

So under what “safety and soundness” “financial stability” or “consumer protection” pretexts were they nixing these crypto products under? None that they had enumerated. The assets weren’t being held by the banks, they were held by NYDIG on behalf of bank clients. So Bitcoin’s volatility was irrelevant.

NYDIG is a reputable and fully licensed and regulated institutional Bitcoin custodian with a stellar track record. No unusual risks there. There were no real OFAC or AML risks with the product, since it was a closed loop system with no withdrawals. And clearly, banks making it easier for their clients to buy and sell bitcoin poses no systemic risk to the banking system.

The FDIC’s mandate isn’t to nitpick every aspect of a bank’s product suite, especially not the creation of a fintech-style product that allows a bank to share user credentials with a third party brokerage to let them individually purchase an asset of choice. The FDIC’s job is to provide depository insurance, and then generally monitor banks by evaluating management practices, asset quality, capital adequacy, earnings, liquidity, market risks, etc. Taking a fine tooth comb through a bank’s product suite strikes me as unusual to say the least.

In October 2023, the FDIC Office of the Inspector General released a semi-redacted report critically reviewing the FDIC’s strategies. The OIG admitted that the FDIC had been, at a minimum, unclear and vague with the banks. The report, redacted though it is, is remarkable. It’s the FDIC telling on itself.

fdicoig.gov/sites/default/…

The most important passage is annotated below. The FDIC admits that in these pause letters, the FDIC did not establish a timeline for actually reviewing the banks’ disclosed crypto programs. They didn’t tell them what would a termination of the review would look like. The FDIC said that crypto products were risky, but wasn’t able to tell banks how or why. This is remarkable. The FDIC asked these banks to put their crypto programs on ice, but had plan to actually give them any feedback or guidance.

Unsurprisingly, as the OIG says, this left banks with the impression that the FDIC wasn’t “supportive of financial institutions engaging in crypto-related activities”. Not exactly a shock. The FDIC demanded all these banks inform them of their crypto activites, asked them to pause them indefinitely, and then gave few if any of them meaningful feedback.

This OIG report tells the story of a rogue agency with no plan or meaningful understanding of crypto “risk” to banks demanding that they report to them, asking them to stop, and then not giving them any timeframe for a greenlight. And we don’t have the full details, because getting information out of the FDIC is like pulling teeth. The important parts of the report are redacted.

Returning to the NYDIG product again, I think it’s very clear it posed no safety or soundness risks to the banks themselves, and few if any risks to the actual end users, aside from the normal market risk of Bitcoin. But the FDIC doesn’t go around telling banks they can’t let users wire money to Fidelity or Schwab to buy volatile stocks. Why should Bitcoin be treated any different?

I’m very curious as to what the other crypto-asset products banks were trying to launch in 2022/23. Suffice to say, none of them were launched. But hopefully, one day we will learn just how far the FDIC set us back by slamming the brakes on all bank crypto activity.

Lastly, I will note that the OIG report strongly rebuts the claim from the recent debanking critics that the banks spontaneously derisked crypto of their own accord, rather than in response to regulatory pressure.

This is not the case. In early 2023, AFTER the collapses of 2022, 96 banks were still eager to support the crypto space, according to the FDIC’s own report. Notably, Singature and Silvergate had built their entire businesses around support for crypto. Even today, businesses like Customers, Cross River, and Lead have aimed to fill the gap left by Signature/Silvergate (although they have done so with considerable regulatory opposition). Banks are a heterogenous group, and while some surely deigned to support crypto clients of their own accord, it is a fact that many banks were keen on supporting crypto.

I look forward to the inquiries into the FDIC by Rep French Hill and other members of Congress. I believe that the crypto industry and the American public in general deserve answers as to why the FDIC stonewalled hundreds of banks from offering products that they, and their clients wanted. And of course, we need to get all the details on OCP2.0 and the 15 percent depository thresholds.