Recent news strongly indicates that the fintech and crypto space is about to have an increased level of oversight and regulatory burden. Although 2021 and 2022 have been busy years for the regulators regarding fintechs and crypto, several recent events underscore concerns.
I will first focus on statements made on September 7, 2022 by Michael Hsu, Acting Comptroller of the OCC during a conference in New York. He stated “The de-integration of banking services that is taking place now has its roots in technology, data, and operations. It is affecting all banks, not just the large money-center banks. My strong sense is that this process, if left to its own devices, is likely to accelerate and expand until there is a severe problem or even a crisis.”
I see Hsu’s statements as a shot across the bow of fintechs and the financial institutions that sponsor fintech activities. Both bankers and fintechs need to take note. Up to this point, regulators have generally used a “careful and cautious” approach to fintechs and crypto. Things start to change when the language speaks of severe problems.
On September 16th, 2022 the Department of Justice released a document titled “Justice Department Announces Report of Digital Assets and Launches Nationwide Network” regarding the role of law enforcement in detecting, investigating, and prosecuting criminal activity related to digital assets. “As digital assets play a growing role in our global financial system, we must work in tandem with departments and agencies across government to prevent and disrupt the exploitation of these technologies to facilitate crime and undermine our national security,” said Attorney General Merrick B. Garland.
“The efforts announced today reflect the commitment of the Justice Department and our law enforcement and regulatory partners to advancing the responsible development of digital assets, protecting the public from criminal actors in this ecosystem, and meeting the unique challenges these technologies pose.”
Crypto is generally divided into three categories of illicit use: 1) cryptocurrency as a means of payment for or manner of facilitating criminal activity; 2) the use of digital assets as a means of concealing illicit financial activity; and 3) crimes involving or undermining the digital asset ecosystem. It is clear that the DOJ (as well as banking regulators) will take necessary actions to reduce or eliminate as much illicit activity as possible. Stronger laws and changes to the Bank Secrecy Act are a given.
It is not just the DOJ that is interested in crypto. The Securities and Exchange Commission is seriously involved. There has been much debate on whether crypto is a security, which would impose additional regulatory requirements on widely traded digital assets. Discussions often center around whether digital tokens are merely a different method of selling shares of a stock to raise money. Equally as important, fraud reduction is taking place. On August 1, 2022 the SEC issued a press release charging eleven individuals in a $300 million dollar crypto pyramid scheme. Events such as these place a regulatory spotlight on the crypto space. Stablecoins are also under scrutiny because contrary as their name suggests, are not always so stable. One final note is that states are starting to get more involved. California had a proposed crypto oversight bill that was drafted however was vetoed by Governor Newsom on September 23, 2022. Expect more to come.
This is not the first time a financial services product or technology has evolved faster than the laws and regulations. I was an early adopter in issuing stored value cards and recall that the industry as a whole was a bit of the wild west until regulatory guidance was issued and consistent examination processes implemented. In addition, I was helping to set best practices in cannabis banking long before formal guidance was issued. I see the fintech space and innovation as being ahead of the regulatory curve with crypto stretching even further ahead.
Evolve or perish. I see innovation and technology as a good thing. I see fintechs and the banks that sponsor them as an improvement to our economy and as moving the development of financial services forward. For many financial institutions, fintechs are starting to eat your lunch. The crypto industry is right around the corner coming for dessert. Consumers are wanting to interact differently with banks and credit unions than before. Although I see a lot of interest in banking fintechs, only a handful of financial institutions seriously bank the crypto space. I think that part of the problem is that many bankers that do not fully understand fintechs or crypto. If you think a “bit” goes on a horse, a “byte” is what you had to eat, and worry if your “blockchain” will ever rust, you are in this category. Nothing wrong with that at all, but know that there are entrepreneurial bankers out there that are figuring out ways to take business away from you. I believe that blockchain technology is the future of banking and that our legacy systems will one day be displaced. We will continue to see development and innovation. There is definitely a reason as to why banks such as JPM Chase invest $12 billion per year on technology and I look forward to what comes next.
Over the past 30 years I have worked in both banks and fintechs. I am a conservative banker but consider myself entrepreneurial. I do not shy away from risk but take the more difficult path of figuring out how to mitigate risk in a safe and sound manner. I was speaking at a banking conference in South Carolina on cannabis banking and was pulled aside by an attendee prior to going on stage. I was asked “What’s the real secret to bank cannabis?” I replied with three simple words: Sound banking fundamentals. The same is true for fintech and crypto banking. Communicate with your regulators, follow all relevant guidance, and practice sound banking fundamentals.
If you a fintech or crypto company reading this article, expect change. Your sponsor financial institution is subject to banking regulations, and you need to start thinking like a banker. Compliance needs to be at the forefront and not an afterthought. Be proactive and comply with your sponsor financial institution as well as all applicable regulations. At the end of the day, you are a compliance company that just happens to offer digital assets and financial services. I actually see technology eventually saving the fintechs. Using data to combat AML from enhanced eKYC, increased transparency, and transaction monitoring is what fintechs and their bankers need to continue to support the industry.
Not every institution banks fintechs, but many have interest. I believe that the crypto space will increase significantly once additional regulations are in place. This article is not a cautionary tale for either bankers or fintechs, but rather to find opportunity with careful planning, execution, and compliance where others may not bother to go.