Article

Crypto Asks Lenders to Show Them the Money; Banks Hesitant

In the ninth edition of the Two Worlds Colliding series, we explore regulatory activity, crypto adoption both domestically and globally, security concerns, and the potential future of digital finance.

By Alma Angotti, Jonathan Shiery

In March, the crypto industry watched as three of the most “crypto-friendly” banks in the U.S. —  Silvergate, Silicon Valley Bank, and Signature — collapsed within a week. Although the failures were at least partially due to improper risk management practices, the deep relationship between these institutions and the crypto industry is likely to have significant implications for crypto banking, due to other banks fearing balance sheet volatility and needing to project stability to the public.

It seems counterintuitive. The crypto industry often prides itself on bolstering an independent financial system that caters to the individual and excises intermediaries. However, this vision for independence actually relies significantly on the ability to use current intermediaries (banking institutions).

In the aftermath of Silvergate, Silicon Valley Bank, and Signature collapsing, crypto companies have struggled to find new banking partners. In fact, one of the reasons there was a concentration of risk in these banks was the fact that many of the larger banks were not willing to provide banking services to customers they consider “higher risk,” like cryptocurrency exchanges and money services businesses. We’ve seen examples of this challenge in the past.  A bank among the leaders in assets managed removed trading platform Swan Bitcoin from its corporate account in October, allegedly without warning. When banks refuse crypto clients, or remove them as clients, there is a threat that crypto companies will not be able to make payroll or maintain operations. Historically this reluctance has been borne out of a perceived banking risk associated with serving crypto clients.

“Overwhelmingly, banking is the challenge for crypto companies…A lot of people in crypto are denied access to banking services. It’s a real problem,” remarked William Quigley, the cofounder of Tether, a stablecoin issuer.1  The crypto industry concentrated reliance on Silvergate and Signature for its banking needs due to their willingness to accept crypto clients. Crypto companies now face an urgent challenge in finding alternative banking partners willing to establish a cooperative relationship.

In the ninth edition of the Two Worlds Colliding series, we explore regulatory activity, crypto adoption both domestically and globally, security concerns, and the potential future of digital finance.

 

Cryptocurrency Value Amidst Banking Concerns

Bitcoin (BTC) and Ether (ETH) have largely outperformed the traditional stock market this year. BTC is up more than 70% since the beginning of the year, and ETH is up almost 50%. Meanwhile, Nasdaq (IXIC), the S&P 500 (SPX), and the Dow (DJI) have seen much lower returns, as shown in the graphic below.2

The relative strength of cryptocurrencies compared to the stock market can likely be attributed to multiple potential factors, but one that ultimately sticks out is the downfall of Silicon Valley Bank and Credit Suisse in early March.

The graphic below shows that BTC and ETH prices grew substantially following the news regarding Silicon Valley Bank and Credit Suisse, which could be interpreted as a sign that investors are buying into cryptocurrency as an alternative investment and store-of-value outside of the traditional banking system.

Major cryptocurrency and stock indices 

Regulators Don’t Let Up On Crypto-Company Scrutiny

The relationship between the cryptocurrency industry and the U.S. regulators (particularly the U.S. Securities and Exchange Commission (SEC)) may be reaching new levels of tension. The industry’s calls have been consistent — the industry urges the SEC to issue rules applicable to crypto companies. The SEC, however, has responded by building implied rules through its enforcement actions, application rulings, and policy decisions that certain crypto companies have deemed insufficient or unclear. There is a lack of consensus on which party is “right” —  whether crypto companies are choosing to ignore the SEC’s implied requirements, or whether the SEC is causing ambiguity for industry stakeholders.3

As of late February, the SEC has issued dozens of actions aimed at defining a crypto security and crypto exchanges. There may be tension between the industry and SEC Chair Gary Gensler after his remarks criticizing crypto companies, alleging that such companies are openly scorning the SEC and feigning ignorance of U.S. regulations. “The law’s pretty straightforward,” Gensler told CoinDesk.4

In March, the Commodity Futures Trading Commission alleged that a major cryptocurrency exchange has offered unregistered derivatives products and encouraged customer and employee practices that evade compliance best practices and requirements; the exchange is now being charged with violating futures transactions laws, failure to register as a futures commissions merchant, failure to properly supervise the business, poor know-your-customer and anti-money laundering processes, and more.5

In March, another major cryptocurrency exchange was issued a Wells Notice from the SEC, which warned that the SEC identified potential violations of securities law — this is the second warning the SEC has issued to a crypto entity this year, issuing another to a stablecoin issuer in February.6

 

Bad Actors Adopt New Tactics

The first quarter of 2023 was relatively quiet regarding large-scale security breaches. Although there were some large blockchain heists, the growing trends amongst hackers have been targeting high net worth individuals and non-fungible token (NFT) rug pull scams.

  • A recent report published by Crystal Blockchain identified the growing trend of NFT “rug pull” scams, in which project founders disappear with users’ funds. In 2022, 48 such scams occurred, with 41 of them occurring in the second half of the year7.
  • In February, $88M worth of crypto was stolen when a Defi borrowing protocol, Bong DAO, was compromised. The hackers compromised the protocols’ smart contract and manipulated the price of AllianceBlock tokens.8
  • Crypto exchange Algodex and wallet provider MyAlgo suffered security breaches and have been unable to resolve the issue. Both companies have been urging customers to withdraw their funds. This security breach has resulted in $9.2M stolen from MyAlgo and Algodex customers.9
  • Trezor, a hardware cryptocurrency wallet provider, warned its customers of a targeted phishing attack. The hackers are reaching out to Trezor wallet holders with fake messages containing links to a copycat Trezor website, where user login credentials are stolen.10

 

Strategic Partnerships Expand APAC Products, Bridge TradFi and DeFi Gaps, and Offer Crypto-Tax Expertise to Investors

  • Wirex, the London-based developer of the first crypto-enabled credit card, announced its global partnership with Visa to offer card services in the UK and select APAC markets, expanding its crypto-linked payments to more than 40 countries.11 Soon afterward, Wirex announced its partnership with Novatti — headquartered in Australia — to expand card issuance capabilities to the Australia market and round out its APAC presence.12
  • Valour, a publicly listed company that bridges decentralized finance (DeFi) and Capital Markets, has entered into a strategic partnership with Spirit Blockchain Capital Inc., where Valour will participate in the private placement being undertaken by Spirit.13 Spirit and Valour will establish specific objectives, KPIs, and key results for this partnership. Valour’s CEO views the partnership as a commitment to building the leading decentralized digital asset management firm.
  • Arbor Digital and Polygon Advisory Group have announced a strategic partnership to provide Arbor Digital clients with access to Polygon’s tax-planning strategy expertise in the crypto-asset investment industry.14  Arbor Digital is a direct exposure crypto-asset investment solution for individual investors and registered investment advisers, and Polygon Advisory Group specializes in crypto-tax services.

 

Decentralized Finance and Security are Top-of-Mind for Leading Web3 Institutions

  • Web3 native payment aggregator Airswift CEO Dr. Yan Zhang is building Pelago, a decentralized payment aggregator where merchants can withdraw funds from an aggregated, decentralized liquidity pool. Pelago aims to avoid the risks of a centralized payment gateway like that of FTX, and instead present an option where the customer pays into the liquidity pool, the merchant withdraws from the pool, and providers receive yield from transaction fees. Transactions will be fully encrypted.15
  • AllianceBlock plans to use its decentralized and trustless blockchain infrastructure to tokenize TradFi instruments in a partnership with Alpha Blue Ocean’s private digital asset investment arm, ABO Digital.16  AllianceBlock’s Nexera Protocol can wrap the tokens in conventional Actively Managed Certificates — resulting in compliant, structured products that can provide crypto projects access to liquidity from institutional capital providers. This will enable lower-risk investment in crypto initiatives from institutional and individual investors.

Fordefi’s Multi-Party Computation wallet has received SOC 2 Type II certification from Ernst & Young, demonstrating the strength of security, privacy, and processing integrity for this institutional DeFi wallet.17  Fordefi’s wallet is the first and only institutional DeFi wallet to be granted this certification, and comes at a time when the ability to safely transact and hold digital assets is a prime focus for financial institutions.

 

Global Adoption Trends Show Mixed Signals

While widespread optimism remains for long-term adoption, short- and medium-term sentiment is currently mixed. This may be due to inconsistent regard as to how recent market volatility and tightening monetary policies will impact blockchain technology adoption broadly. 

  • Financial sanctions on Russia have accelerated the development of cross-border payment systems that avoid the U.S. dollar — cross-border Central Bank Digital Currency (CBDC) tests doubled in number from 2021.18  One hundred fourteen countries, representing 95% of the global GDP, are exploring CBDCs.19
  • The New York Fed, Boston Fed, and SWIFT are continuing to test CBDCs through various pilot programs. The N.Y. Fed, in partnership with several banks, has issued tokens and settled transactions through simulated central bank reserves as a proof of concept. SWIFT, along with 18 central and commercial banks, saw 183 digital payments sent through two blockchain networks in a sandbox environment in the first phase of its own pilot. The Boston Fed, in partnership with Massachusetts Institute of Technology’s Digital Currency Initiative, is progressing through Project Hamilton, which is a multiyear exploratory research collaboration exploring the technical feasibility of a general purpose CBDC.20
  • According to a new study by Mastercard, stablecoins have been used for everyday purchases by more than a third of Latin Americans. The use of cryptocurrencies pegged to the U.S. dollar is expected to continue to grow because of high inflation and macroeconomic turbulence in developing countries.21
  • Coinbase, the world’s second-largest cryptocurrency exchange, saw a 12% quarter over quarter reduction in transaction volume, according to their Form 10-Q. Their efforts to diversify revenue sources have been met with significant regulatory scrutiny.22
  • In an interview with Barron’s, Alex Thorn, head of research at Galaxy Digital, said Bitcoin’s resilience, predictability, and relative safety could see renewed interest amid the recent turmoil in the fractionally reserved banking system.23
  • Molly White, a crypto researcher and software engineer, noted in her newsletter that USD-pegged coins to dollar off-ramps were limited early in the banking crisis, leading to many investors moving into different crypto assets such as bitcoin. With bitcoin currently experiencing low liquidity, it could serve as an exit for traders nervous about stablecoins.24
  • Net crypto ATM installations have declined four out of the previous seven months, with March 2023 having the largest monthly decline on record. There are 33,727 crypto ATMs still in service, after 3,627 were removed from the network in March.25

 

U.S. Adoption of Blockchain Technology Remains Strong

The adoption of blockchain technology continues to increase in the U.S. among companies and individuals. While cryptocurrencies have seen a dip in investment activities this quarter, the adoption of its underlying technology remains strong. 

  • Tokenization of real-world assets continues to gain traction among large companies, making industry watchers upbeat about the trend in 2023. Some big-name companies utilizing blockchain technologies for financial instruments include: Credit Agricole CIB, Swedish bank SEB, Siemens, J.P. Morgan, and WisdomTree.26
  • The U.S. Air Force, under its Strategic Technology Reachback and Analysis program, invested $30M with blockchain firm SIMBA Chain. This investment will fund the development and deployment of supply chain management blockchain applications designed to improve efficiency and comprehensive management of assets within the Department of Defense supply chain.27
  • A recent survey revealed 50% of U.S.-based freelancers are comfortable in earning a significant portion of their income through digital coins and assets, while 20% of gig workers have already received crypto payments.28

 

What Luminaries Are Saying

Lindsay Lohan was paid $10,000 to promote Tronix tokens offered by Justin Sun’s company Tron via a February 11, 2021, tweet: 
Exploring #DeFi and already liking $JST, $SUN on $TRX. Super fast and 0 fee. Good job @justinsuntron.29

Gurbir S. Grewal, director of the SEC’s Division of Enforcement, remarked on Lohan’s failure to disclose that the tweet was a paid endorsement and warned Justin Sun’s misleading potential investors:
“This is the very conduct that the federal securities laws were designed to protect against regardless of the labels Sun and others used.”30

Rebecca Rettig tweeted after being named the first Chief Policy Officer of Polygon Labs in February:
This role is for the entire web3 community. We will advocate for base layer protection, but also for every aspect of the builder ecosystem — DeFi, NFTs, web3 gaming, & innovative apps growing the web3 world. Decentralization is the whole point, & must be protected. We will also advocate for sensible, activities-based reg for crypto native entry points — front ends, wallets, bridges. You name it, we’re here for you.31

 

What We Will Look For: Collaboration Between Regulators and Banks Needed for the Advancement of the Cryptocurrency Industry

The cryptocurrency industry is faced with a large obstacle in the wake of the bank closures earlier this year. On one hand, major cryptocurrencies (like BTC and ETH) have largely outperformed the U.S. stock market. The relative strength of cryptocurrencies could indicate that investors are increasingly turning to digital assets as a viable alternative to traditional investments, a trend that is likely to continue as the industry matures and becomes more mainstream. 

However, the recent collapses of Silvergate, Silicon Valley Bank, and Signature highlight a critical challenge faced by the cryptocurrency industry — the lack of reliable banking partners. Crypto companies need banking partners to operate smoothly and continue to grow. However, the reluctance of traditional banks to serve crypto clients has left the industry vulnerable. Smaller companies may struggle to make payroll or sustain normal operations. 

To address this challenge, regulators and banking institutions must work together to create a more welcoming environment for crypto companies. This means addressing perceived risks associated with banking crypto clients, providing more clarity around regulations, and creating a framework that encourages responsible innovation. By doing so, the crypto industry will be able to continue to grow and provide valuable services/alternative investments to a broad range of individuals and businesses around the world.

This article is co-authored by Shantel Silva with contributions from Jared Sanderson, Evan Robinson and Kevin Michels.


1 https://www.wired.com/story/crypto-banking-crisis/.
2 https://www.tradingview.com/.
3 https://www.coindesk.com/policy/2023/02/21/secs-shadow-crypto-rule-taking-shape-as-enforcement-cases-mount/?utm_source=Sailthru&utm_medium=email&utm_campaign=First%20Mover%20New%20Template.
4 https://www.coindesk.com/policy/2023/02/21/secs-shadow-crypto-rule-taking-shape-as-enforcement-cases-mount/?utm_source=Sailthru&utm_medium=email&utm_campaign=First%20Mover%20New%20Template.
5 https://www.coindesk.com/business/2023/03/27/binance-and-cz-sued-by-cftc-over-regulatory-violations/.
6 https://www.cnbc.com/2023/03/22/coinbase-warned-by-sec-of-potential-securities-charges.html.
7 https://crystalblockchain.com/security-breaches-and-fraud-involving-crypto/.
8 https://www.coindesk.com/consensus-magazine/2023/03/24/119m-in-stolen-crypto-so-far-in-2023-nft-rug-pulls-on-the-rise-crystal-blockchain/.
9 https://cointelegraph.com/news/algodex-reveals-wallet-infiltrated-by-malicious-actor-as-myalgo-renews-warning-withdraw-now.
10 https://cointelegraph.com/news/trezor-warns-users-of-new-phishing-attack.
11 https://news.bitcoin.com/uk-payments-company-wirex-becomes-visa-global-partner-extends-crypto-card-program-reach-to-over-40-countries/. 
12 https://wirexapp.com/blog/post/weve-partnered-with-novatti-to-bring-our-multicurrency-card-to-users-in-australia-0730.
13 https://www.globenewswire.com/news-release/2023/03/02/2619159/0/en/Spirit-Blockchain-Announces-Strategic-Partnership-with-Valour-Valour-to-Participate-in-Private-Placement-of-CSE-SPIR.html. 
14 Arbor Digital and Polygon Advisory Group Announce Strategic Partnership to Offer Tax Advice and Services in the Crypto Industry (prnewswire.com).
15 https://www.pymnts.com/cryptocurrency/2023/airswift-ceo-says-decentralized-payment-protocols-are-crypto-sector-savior/. 
16 https://finbold.com/allianceblock-partners-with-abo-digital-to-provide-alternative-financing-for-crypto-projects/. 
17 Fordefi Becomes First Institutional DeFi Wallet to Earn SOC 2 Type II Certification (prnewswire.com).
18,19 https://www.atlanticcouncil.org/cbdctracker/.
20 https://www.centralbanking.com/fintech/cbdc/7954761/swift-completes-cross-border-cbdc-settlement-pilot.
21 https://www.coindesk.com/business/2023/01/23/latin-american-stablecoin-adoption-expected-to-grow-amid-high-inflation/.
22 https://www.coindesk.com/business/2023/02/22/what-coinbases-q4-earnings-mean-for-crypto-adoption/.
23 https://cointelegraph.com/news/adoption-and-nerves-crypto-pumps-amid-banking-crisis.
24 https://newsletter.mollywhite.net/p/no-bitcoin-isnt-pumping-because-its.
25 https://cointelegraph.com/news/more-than-3600-bitcoin-atms-went-offline-to-record-largest-monthly-decline.
26 https://www.coindesk.com/markets/2023/04/04/real-world-tokenization-is-surging-as-tradfi-grows-more-receptive-to-blockchain/.
27 https://www.benzinga.com/markets/cryptocurrency/23/02/30673164/us-air-force-boosts-blockchain-adoption-with-30m-investment-in-simba-chain.
28 https://www.analyticsinsight.net/freelancing-boosts-blockchain-adoption-as-50-of-freelancers-accept-cryptos-as-payment/.
29 https://www.cnn.com/2023/03/22/investing/lindsay-lohan-jake-paul-crypto/index.html. 
30 https://www.sec.gov/news/press-release/2023-59. 
31 https://twitter.com/RebeccaRettig1/status/1623672084533547013?s=20.


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