The Fed’s on board: Getting your institution ready for cryptocurrency

As cryptocurrencies become more deeply integrated into the global financial system, there’s growing recognition of the need for financial institutions to function as a compliant bridge to the fiat currency system and act as a trusted custodian of digital assets. This recognition now extends to the Federal Reserve, who recently offered guidance for institutions seeking to engage in cryptocurrency-related activities. In its letter “SR 22-6/CA 22-6: Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations,” the Federal Reserve acknowledged the potential opportunities the emerging crypto-asset sector presents to banking organizations, their customers, and the overall financial system. But it also recognized the significant risks that need to be overcome relating to safety and soundness, consumer protection, and financial stability.

The Federal Reserve acknowledged the potential opportunities the emerging crypto-asset sector presents to banking organizations, their customers, and the overall financial system.

According to the letter, institutions preparing regulatory filings for involvement in cryptocurrency activities must “have in place adequate systems, risk management, and controls to conduct crypto-asset-related activities in a safe and sound manner and consistent with all applicable laws, including applicable consumer protection statutes and regulations.” The Federal Reserve highlighted four key areas of risk for institutions to consider:

• Technology and operations: Cybersecurity risk, network governance, and challenges involved in using open, permissionless networks. 
• Anti-money laundering (AML) and countering of financing of terrorism: Risks associated with money laundering and illicit financing created by the limited transparency of some crypto assets, particularly in the area of identifying and tracking ownership.
• Consumer protection and legal compliance: Consumer protection disclosures pertaining to areas such as price volatility, fraud, and theft or loss of assets. This includes disclosures related to misinformation, operational failures, and cryptocurrency’s legal status.
• Financial stability: Risks to financial stability from certain types of crypto assets such as stablecoins that, if adopted on a large scale, could result in destabilizing runs or disruptions to payment systems.

For most financial institutions considering participation in the cryptocurrency markets, many of these risk factors are essentially an extension of what they’re already doing. 

For most financial institutions considering participation in the cryptocurrency markets, many of these risk factors are essentially an extension of what they’re already doing. 

From the AML perspective, the Federal Financial Institutions Examination Council has had long-standing guidance in place requiring institutions to know their customers, including sources of funds and wealth and any significant and unexplained changes in account activity. Most institutions already have consumers engaged in cryptocurrency activity, necessitating reviews and, where necessary, adjustments to their compliance monitoring to identify suspicious ACH transactions to and from unregulated cryptocurrency exchanges that have a high potential for money laundering. Likewise, banking organizations already have robust consumer protection and regulatory compliance programs in place that can be expanded to include cryptocurrency products and services. So, in many ways, cryptocurrency is just a new product with a unique set of risks that mirror other risks from the past.

How to get started

With regulators signaling that cryptocurrency is here to stay, now’s the time to get ahead of it. If your financial institution is just getting started with cryptocurrency, the following checklist is a good place to start:

• Understand your customers and their expected transactional behavior.
• Build out a platform and put policies and procedures in place based on the Federal Reserve’s guidance around technology and operations, AML, consumer protections, and financial stability. 
• Get a clear sense of customer demand for cryptocurrency products. Consider conducting surveys to find out what percentage of customers are interested in cryptocurrency and the products they’d like to see.
• Decide how your institution wants to participate in the market. Will you connect customer accounts to a cryptocurrency exchange and allow them to purchase cryptocurrency directly from their account? Will you offer cryptocurrency wallets? Will you create investment products?
• Understand the relative risks of each cryptocurrency product or service and how your institution will operationalize it and minimize risk.

As the number of account holders adopting cryptocurrency becomes a more significant portion of your customer base, this is a good time to start planning how you’ll integrate it into your institution’s product mix. The Federal Reserve’s four risk areas can smooth the path to the new products, services, and opportunities, and the associated compliance risk review can open up potential opportunities for efficiency and risk mitigation.