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What Community Banks Need to Know as Crypto Usage Expands

Cryptocurrency is currently an unregulated, speculative investment

By Hannah Flanders

With the increasing rise in popularity of cryptocurrency throughout the U.S., it is no question that banks and regulators alike aim to understand this unique form of encrypted exchange while also helping to protect the millions of individuals who have already invested in, traded, or used digital assets.

In May, crypto investors experienced the most severe price crash the global crypto market has ever seen. As inflation rises and individuals continue to draw what money they have left out of the market, prices continue to drop each day.

Cryptocurrency is a speculative investment for both banks and individuals engaging with it, and currently, there are no specific regulations tailored to it. As the market this last year has shown, although the market experiences rapid unpredictability and growing connections to money laundering activity, consumers and business alike continue to be interested in the potential benefits of this transferable wealth.

In this, many regulators are attempting to harness the security of financial institutions that are entering into the untamed landscape. As agencies — including the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) — jockey to assert regulatory authority and supervision over digital assets, it is important for banks and their counsel to consider that no regulations have been established regarding bank involvement with digital assets.

In March 2022, President Joe Biden issued an Executive Order regarding the need to establish consumer/investor protection and focus on financial stability, inclusion, and preventing against illicit activity within the American crypto market. Of this came an increase in guidance issued by several national agencies.

Guidance by the Federal Deposit Insurance Corporation (FDIC) states that all FDIC-supervised institutions that intend to engage in, or that are currently engaged in, any activities involving or related to digital assets should notify the FDIC. This action aims to provide supervisory feedback in the wake of activities that pose significant safety and soundness risks as well as financial stability concerns to banks. Additionally, the Office of the Comptroller of the Currency (OCC) advises that banks should not engage in cryptocurrency until they have notified their supervisory office and received a non-objection form.

The Financial Crimes Enforcement Network (FinCEN) has also issued several advisories to banks regarding illicit activity involving cryptocurrency. Banks should demonstrate compliance with their anti-money laundering (AML) programs and be aware of the prevalence of unregistered entities without sufficient AML controls. As with every new relationship, banks are advised to also consider the Bank Secrecy Act of 1970 (BSA) when engaging with digital assets.

In addition to guidance from federal agencies, banks should also be aware that state agencies and legislators may also begin acting on Biden’s order. In this, more proposed legislation to encourage innovation in the financial sector while also enforcing consumer protections may begin appearing at both the state and federal levels.

Currently, only one legislative act has been proposed at the federal level by U.S. Senators Kirsten Gillibrand (D-N.Y.) and Cynthia Lummis (R-Wyo.). If enacted, the Responsible Financial Innovation Act (RFI) would establish regulatory framework for digital assets by providing industry and regulator clarity, clarifying standards, establishing jurisdictional boundaries, and protecting consumers.

At the state level, Wisconsin’s Department of Financial Institutions (DFI) and Department of Agriculture, Trade, and Consumer Protection (DATCP) have cautioned Wisconsin banks and consumers of the risks of crypto. While no legislation has yet to be proposed or passed, Wisconsin bankers should expect that — like many other states — state regulation may be forthcoming.

For questions on legal developments or regulations related to crypto or other compliance matters, please reach out to WBA legal at 608-441-1200.

*Update from originally published article: On Tuesday, August 16, guidance was issued for Federal Reserve System (FRB)-supervised banking organizations engaged in or seeking to engage in crypto-asset-related activities. The guidance includes the instruction that a banking organization need notify its lead FRB supervisory point of contact regarding such activities.