Our overview of the Top 10 Considerations for Financial Institutions in 2020 series noted that financial institutions will continue to face challenges in a number of corporate, compliance, and risk areas, especially in light of COVID-19 and a potentially slowing economy in 2020. Our eighth consideration is the growth of digital currencies. In just the past few years, the number of digital currencies has exploded as use cases expand and gain traction.
With respect to financial institutions, as the potential intersection of digital currencies and traditional financial institutions generates research and risk analysis, some non-bank institutions are emerging with a focus on money transmitter or virtual currency business licenses at the state level in order to provide products and services related to digital currencies. In some states, such as New York, Washington, and Louisiana, for example, state regulators have come forward with specific guidance on products and services related to digital currencies, as well as specific licensing requirements for digital currency businesses. In addition, Wyoming has been one of the most accepting of digital assets. The state has enacted a number of laws specific to digital assets and is authorized to charter Special Purpose Depository Institutions under a statute enacted last year.
For traditional financial institutions such as banks, providing services linked to digital currencies—digital assets more broadly—is a complicated endeavor. Depending on the characteristics and uses, digital assets can be considered money, securities, commodities, or property. Traditional financial institutions will need to consider what digital assets they are dealing with before they develop products or services around these assets.
While there are certainly opportunities with digital currencies, there are also a number of risks. These risks are just one of the focus areas for state and federal banking agencies studying digital currencies and potential bank products and services associated with this technology. Given that these are digital currencies using various forms of distributed ledger technology, data security and the risk of a cyberattack is paramount.
Agencies have also been keen to review money laundering risks given the anonymous nature of some digital assets. For example, the Financial Crimes Enforcement Network has issued advisories on illicit activity involving virtual currencies and guidance specific to persons administering, exchanging, or using virtual currencies.
Despite these risks, there are opportunities associated with innovation in payments technology, financial inclusion, and cost reduction. As we mentioned in our sixth consideration for financial institutions in 2020 on fintech, the Office of the Comptroller of the Currency’s (OCC) recent Advanced Notice of Proposed Rulemaking indicated that the OCC was reviewing its regulations on digital activities of banks “to ensure that its regulations continue to evolve with developments in the industry” and invited comments and questions related to, among other things, blockchain technologies, cryptocurrencies, and cryptoassets.
On July 22, the OCC published an Interpretive Letter clarifying the authority of national banks and federal savings associations to provide cryptocurrency custody services on behalf of customers, including by holding the unique cryptographic keys associated with a cryptocurrency. In its Interpretive Letter, the OCC recognized that banks have traditionally provided safekeeping and custody services, and that providing cryptocurrency custody services is a modern form of such traditional bank activities. As always, banks are reminded of the unique risks associated with digital currencies and the overarching expectation that such services are provided in a safe and sound manner.
Finally, during the Federal Reserve Bank of San Francisco’s Innovation Office Hours virtual chat last week, Federal Reserve Governor Lael Brainard indicated that “the Federal Reserve is active in conducting research and experimentation related to distributed ledger technologies and the potential use cases for digital currencies.” Indeed, the Federal Reserve has been conducting in-house experiments, including through its Technology Lab, in order to study the opportunities and risks of digital currencies and distributed ledger platforms on which they could be housed. In addition, the Federal Reserve Bank of Boston is collaborating with Massachusetts Institute of Technology (MIT) researchers to build and test a hypothetical digital currency that would be used for central bank purposes. The goals of this research include assessing the safety and soundness of digital currencies, understanding the private sector arrangements around digital currencies, and understanding the opportunities, risks, and limitations of possible technologies for digital forms of central bank money.
1. Financial institutions should be developing a basic understanding of digital currencies and the underlying technology that supports them—distributed ledger technology.
2. For financial institutions that are or may be servicing digital assets, including digital currencies, special attention should be given to the digital nature of these assets and the unique risks presented. Consideration of traditional guidance on new products and services can also offer broad guidelines for developing this line of business.
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