Last year was a difficult time for crypto investors, with billions being wiped out of the cryptocurrency market and the collapse of major exchange FTX dampening sentiment toward digital assets.
The fallout saw people losing their life savings overnight, with more than a million people and businesses reportedly owed money by FTX.
In light of the events of 2022, major financial regulators in the U.S. have come together for the first time to warn banks about the risks involved with being tied to the unpredictable crypto industry.
In a joint statement on Tuesday, the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency sounded the alarm over the risks crypto assets posed to banking organizations.
“The events of the past year have been marked by significant volatility and the exposure of vulnerabilities in the crypto-asset sector,” the agencies said. “These events highlight a number of key risks associated with crypto-assets and crypto-asset sector participants that banking organizations should be aware of.”
Last year, cryptocurrencies across the board suffered a widespread selloff that became known as the Crypto Winter, with more than $200 billion wiped off of the market in a single day back in June. Some experts have predicted the phenomenon could last through 2023, and possibly continue into next year.
The selloff, exacerbated by the implosion of major crypto exchange FTX in November, led to speculation over whether the world is witnessing “the end of crypto,” with some heralding FTX’s collapse as the cryptocurrency market’s “Lehman moment.”
As well as warning lenders about the “significant volatility” of crypto markets, U.S. regulators urged financial institutions on Wednesday to be wary of the risk of fraud and scams within the crypto sector, as well as legal uncertainties relating to ownership rights and a lack of robust risk management and governance practices at cryptocurrency firms.
Also among the regulators’ lengthy list of risk factors surrounding the crypto sector was a warning of a “contagion risk” resulting from issues like opaque lending, investing, funding, service, and operational arrangements.
They added that there were heightened risks associated with decentralized networks, which included vulnerabilities related to cyber-attacks, outages, lost or trapped assets, and illicit finance.
“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system,” regulators cautioned.
While they noted that banks in the U.S. are neither prohibited nor discouraged from providing services to customers operating in the crypto sector, issuing or holding crypto assets was “highly likely to be inconsistent with safe and sound banking practices.”
“Banking organizations should ensure that crypto-asset-related activities can be performed in a safe and sound manner, are legally permissible, and comply with applicable laws and regulations, including those designed to protect consumers (such as fair lending laws and prohibitions against unfair, deceptive, or abusive acts or practices),” officials said.
“[Banks] should ensure appropriate risk management, including board oversight, policies, procedures, risk assessments, controls, gates and guardrails, and monitoring, to effectively identify and manage risks.”
What do banks think of crypto?
Wall Street banks are divided on the merit of cryptocurrencies, particularly in the wake of a turbulent 2022.
JP Morgan CEO Jamie Dimon, a renowned crypto skeptic, has likened investing in cryptocurrencies to buying useless “pet rocks.”
However, JP Morgan—like Morgan Stanley and Goldman Sachs—has a dedicated group for focusing on cryptocurrency.
Deutsche Bank, Wells Fargo, Citigroup and Bank of America have invested in crypto staffing divisions in recent years, according to CNBC, while Standard Chartered, UBS and BNY Mellon had invested millions in crypto assets by 2021, Business Insider reported.
Others have taken a far more wary approach.
HSBC, for example, said in 2021 that it would refuse to process cryptocurrency payments in Britain.
While many lenders have jumped on the crypto bandwagon in recent years, many have warned that investors in the market could still be in for further pain.
In a research note at the end of last year, Standard Chartered’s global head of research, Eric Robertsen, warned that investors could be caught off guard by a “surprise” Bitcoin plunge that would send the digital asset a further 70% lower in 2023.
Meanwhile, JPMorgan’s analysts believe that its bottom is still yet to be reached, with the bank predicting in November that it will drop to around $13,000 while the crypto market suffers a “cascade of margin calls.”
