Federal Agencies Outline Risks for Banks Considering Crypto Custody

Three US federal agencies have outlined vital risks for banks considering crypto custody, aiming to prepare them for the expanding cryptocurrency landscape and its challenges ahead.

Federal agencies highlight banks’ risks with crypto custody services

Federal agencies in the United States recently released an important document outlining the risks that banks face if they choose to offer crypto custody services. This guidance arrives as interest in crypto custody among traditional banks appears to be growing, with reports suggesting that some financial institutions may be looking to dive into this complex asset space. While the document doesn’t introduce new supervisory standards, it does provide a robust framework for banks contemplating this venture—an important move indeed as the crypto market continues to evolve.

Banks face significant risks in crypto engagement

The report, entitled “Crypto-Asset Safekeeping by Banking Organizations,” specifies several critical areas banks must assess before entering the crypto space. Firstly, banks must grasp the intricacies of this rapidly changing asset class, which can be fraught with volatility and complexity. Additionally, they need to be aware of potential liabilities, especially if crypto assets go missing. Equally crucial are the legal responsibilities they must adhere to, particularly regarding the Bank Secrecy Act and Anti-Money Laundering regulations, which are central concerns in any financial dealings.

Third-party custodians and their responsibilities

Interestingly, many banks do not opt for handling crypto custody directly; instead, they often collaborate with third-party providers. For example, BlackRock has previously relied on both Coinbase and Anchorage for the custody of its Bitcoin assets. Moreover, BNY Mellon, the oldest bank in the US, has also started to offer custody options for digital assets to their clients. According to the joint document, banks remain accountable for any activities conducted by sub-custodians, meaning if there is a breach or hack, leading to financial losses, the bank could be held liable.

Importance of audits in crypto dealings

Auditing plays a vital role in this whole process, as highlighted by the federal agencies. They stress that audit programs should be robust enough to cater to the unique nature of crypto assets. This includes elements like key generation, transfer controls, and ensuring staff have the necessary expertise. Where an in-house audit framework is lacking, banks should consider enlisting external help to evaluate their crypto custody operations. Proper due diligence and management are essential to mitigating risks associated with this highly volatile market.

Banks optimistic about entering the crypto market

There’s a growing sentiment among banks that the current regulatory landscape might finally be turning in their favour. Recent reports indicate that a collective of large banks is exploring options for launching a joint crypto stablecoin. The easing of stringent regulations by governing bodies has made the crypto sector appear more accessible. For example, just recently, the Federal Reserve has blurred the lines regarding the so-called “reputational risk” that previously hindered banks from engaging more freely with crypto businesses.

Crypto companies pivot to traditional banking

It’s worth mentioning that some companies built entirely around cryptocurrencies are now looking to become banks themselves. Ripple has taken steps to secure a banking licence through the OCC, while Circle, known for the USD Coin, has done the same. This shift in approach signals a potential evolution in the industry, as native crypto firms seek legitimate banking status, impacting the broader financial ecosystem.

As traditional banks are navigating the complexities of entering the cryptocurrency realm, the federal guidance serves as a crucial resource. With risks identified and the framework established, banks must weigh their responsibilities and liabilities carefully. The shifting regulatory environment could entice more financial institutions into crypto; however, diligence in safeguarding assets and adhering to legal standards will remain vital.