All eyes are on Fed's Barr to flesh out path forward on crypto rules

The Federal Reserve's top regulator is set to give his first speech on cryptocurrency oversight this week.

Fed Vice Chair for Supervision Michael Barr will deliver remarks on the subject Thursday at the Peterson Institute for International Economics. His address comes at a time when bank regulators in Washington are carving out their positions on digital assets through policy guidance. 

The Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency issued two joint statements on crypto risk management in the first eight weeks of 2023. While nonbinding, the statements have raised concerns among industry participants about a de facto ban on bank engagement with crypto.

Barr is not expected to deviate from the skeptical posture regulators have taken in recent weeks, but advocates and opponents alike will be parsing his words to see if they leave any daylight for crypto to enter the banking system and under what conditions.

Cody Carbone, vice president of the Chamber of Digital Commerce, a crypto lobbying firm, said he expects Barr to adhere to the Fed's official neutrality on whether banks should engage in crypto-related activities, while still focusing heavily on the inherent risks and need to rein them in.

Carbone said he will be listening for any indication from Barr that the Fed's support of innovation in the crypto space is anything more than lip service.

"If you see opportunities, put your money where your mouth is and provide some proposals, work with industry to make sure those opportunities happen here in the U.S. and they're done in a safe and secure environment within U.S. regulatory system," he said. "We just haven't seen that. It's all been about risks."

Meanwhile, those who favor the regulators' efforts to keep bank exposure to crypto at a minimum will be looking for more of the same from Barr.

Regulation/Compliance

Fed's Michael Barr says FTX turmoil shows crypto risk to financial system

November 15, 2022 3:21 PM

"The most important thing for the financial regulators to do, including, importantly, the Fed, is to hold the line and continue to ignore the pressure from the crypto industry and their political allies to rescue crypto by providing them with an unwarranted and dangerous access to Fed facilities and interconnections with the banking system," said Dennis Kelleher, head of the consumer advocacy group Better Markets. "There is literally no legitimate, legal use of crypto and most of the crypto activities are currently illegal offering, selling and trading of unregistered securities and commodities."

Barr has touched on crypto a handful of times as part of broader speeches, in one-off remarks during public appearances and while testifying in front of lawmakers. His comments have generally focused on the risks associated with digital assets and the need for better supervision in the space, though he has insinuated that they belong under the jurisdiction of other agencies, such as the Securities and Exchange Commission and Commodity Futures Trading Commission.

In October, Barr dedicated a segment of his speech on "Managing the Promise and Risk of Financial Innovation" to crypto assets. In it, he said it was important to make sure the activities in the space were regulated commensurately with equivalent activities that take place in regulated markets. The concept of applying similar regulation to like activities has garnered support from both ends of the Fed Board of Governors' ideological spectrum. 

Barr also flagged the risk of banks having a concentration of crypto-backed deposits, including their susceptibility to volatility given the interconnectedness of the digital-asset sector. Notably, San Diego-based Silvergate Bank, a Fed-supervised state-member bank that focuses crypto banking, was subject to this exact type of deposit run just weeks after Barr's remarks, amid the collapse of the cryptocurrency exchange FTX

The Fed, FDIC and OCC issued a joint statement on managing liquidity risks in crypto deposits last month. 

During the downfall of FTX in November, Barr testified in front of the Senate Banking Committee alongside the heads of the FDIC and OCC. He told the committee that the episode spoke to the potential systemic risks that could arise "if interlinkages develop between the crypto system that exists today and the traditional financial system."

Barr and other bank regulators frequently credit the limited connections between banks and crypto companies with preserving financial stability during crypto's tumultuous year in 2022. 

Kelleher said regulator's efforts to keep digital assets at an arm's length from the banking system likely averted a crisis on the scale of the subprime mortgage crisis in 2008.

"That would have meant contagion and bailouts, and that didn't happen because these regulators resisted the pressure and put the public interest in safety and soundness first," he said. "Our view is that they've done an unrecognized, fantastic job of protecting the American people, and they should continue to do that."

Others worry this strategy will allow risks and illegal activities to build up in parts of the economy that are beyond the reach of regulators.

Bryan Hubbard, an independent consultant for financial firms and a former OCC spokesman, said he is concerned this approach could lead to regulatory gaps and blind spots that could lead to spillovers into the traditional financial system. 

"It's very dangerous to, rather than find a way for banklike activity to occur in the full sunshine of the banking space, instead have it take place in dark corners," Hubbard said. "What I'm looking for are regulators providing a path for existing banks to engage in new technology that their customers may benefit from and for companies engaged in new financial intermediation to be able to engage with banks in a way that allows them to conduct business in a safe and sound manner."

Barr's last comments on crypto regulation came during a question-and-answer session with Michael Strain, director of economic policy studies at the American Enterprise Institute on Dec 1. During that conversation, Barr said some of the volatility seen in the crypto sector could have been mitigated through regulation and that while linkages between the banking system and digital assets are few, it is worth examining how they can be managed to best protect financial stability. 

Yet, Barr also noted that whatever approach the Fed takes will not be one that seeks to shut down the digital-asset sector entirely.

"It's important for us not to set up a regulatory environment that stifles innovation. Innovation is really critical to the financial sector. It's critical to the American economy. One of the reasons we have an amazingly vibrant economic system is because we permit, encourage, allow that kind of innovation," he said. "And so we've got to get the balance right. We have to have really good guardrails, so that investors and consumers are protected, so that the safety and soundness of the financial system is protected. And then we need to let innovation flourish within those guardrails, so that we don't lock in old technology or incumbents. And getting that balance right is very, very tricky. We clearly don't have it right now in the world that we're seeing."