Regulators to Banks: Crypto Is a Contagion Risk

After a volatile and controversial year for cryptocurrency in 2022, it is no surprise that regulators have started 2023 with warnings surrounding investment in crypto for banks. The Federal Reserve joined other regulators in warning the banks due to failures of crypto-asset companies, without naming FTX or any other specific companies.

The warnings in some respect are unnecessary as traditional banks have not been quick to jump into the crypto market. The potential benefits to being active in the crypto market have for the most part been offset by banks’ concerns with frauds and scams, a key concern for financial institutions particularly on the retail side of the operation. Contagion risk sited by regulators just makes it all the more problematic.

However, the warning was conspicuous by its absence of specific regulation, and did not discourage banks from making partnerships. If anything, the statements can be seen as an encouraging sign that regulators will help strengthen the credibility of the industry and give guidance for banks to enter into the cryptocurrency market.

As digital coin advocates have pointed out, the fall of FTX did not actually bring about the fall of the currencies, but rather shed light on the caution needed for banks to choose the right partners. It is worth noting that Coindesk, the media company of record for cryptocurrency news, was actually also the one that exposed the problem.

The government agencies said they were going to take a “careful and cautious approach”. Given the cautionary nature that traditional banks have already taken to cryptocurrency, it seems the industry is already in line with the regulators’ take.

However, the industry is still robust and banks will have a major role in helping to stabilize the market and bring credibility to it.