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Feds issue warning over cryptoasset risks

US Federal agencies outlined key risks associated with cryptoassets and cryptoasset sector participants of which they said banking organisations should be aware (File photograph)

Three federal agencies in the US have suddenly issued a wide-ranging warning on the dangers posed to banks by cryptoasset risks.

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency yesterday jointly listed a number of key risks associated with cryptoassets and cryptoasset sector participants of which they said banking organisations should be aware.

The warning is said to be linked to the significant volatility and the exposure of vulnerabilities in the cryptoasset sector experienced over the last year.

Cryptocurrency exchange FTX filed for Chapter 11 bankruptcy protection in November, a collapse that shook the volatile crypto market. It caused a near domino effect that saw more than 100 linked companies file for bankruptcy or suffer heavy losses.

The market lost billions in value, and the consequences of FTX’s rapid decline will likely impact cryptocurrencies well into the future and could even drag down broader markets, analysts have speculated.

The key risks outlined to banking organisations by the federal agencies yesterday are:

•Risk of fraud and scams among cryptoasset sector participants.

• Legal uncertainties related to custody practices, redemptions, and ownership rights, some of which are currently the subject of legal processes and proceedings.

• Inaccurate or misleading representations and disclosures by cryptoasset companies, including misrepresentations regarding federal deposit insurance, and other practices that may be unfair, deceptive, or abusive, contributing to significant harm to retail and institutional investors, customers, and counterparties.

• Significant volatility in cryptoasset markets, the effects of which include potential impacts on deposit flows associated with cryptoasset companies.

• Susceptibility of stablecoins to run risk, creating potential deposit outflows for banking organisations that hold stablecoin reserves.

• Contagion risk within the cryptoasset sector resulting from interconnections among certain cryptoasset participants, including through opaque lending, investing, funding, service, and operational arrangements. These interconnections may also present concentration risks for banking organisations with exposures to the cryptoasset sector.

• Risk management and governance practices in the cryptoasset sector exhibiting a lack of maturity and robustness.

• Heightened risks associated with open, public, and/or decentralised networks, or similar systems, including, but not limited to, the lack of governance mechanisms establishing oversight of the system; the absence of contracts or standards to clearly establish roles, responsibilities, and liabilities; and vulnerabilities related to cyberattacks, outages, lost or trapped assets, and illicit finance.

The statement continued: “It is important that risks related to the cryptoasset sector that cannot be mitigated or controlled do not migrate to the banking system.

“The agencies are supervising banking organisations that may be exposed to risks stemming from the cryptoasset sector and carefully reviewing any proposals from banking organisations to engage in activities that involve cryptoassets.

“Through the agencies’ case-by-case approaches to date, the agencies continue to build knowledge, expertise, and understanding of the risks cryptoassets may pose to banking organisations, their customers, and the broader US financial system.

“Given the significant risks highlighted by recent failures of several large cryptoasset companies, the agencies continue to take a careful and cautious approach related to current or proposed crypto-asset-related activities and exposures at each banking organisation.

“Banking organisations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type, as permitted by law or regulation.

“The agencies are continuing to assess whether or how current and proposed crypto-asset-related activities by banking organisations can be conducted in a manner that adequately addresses safety and soundness, consumer protection, legal permissibility, and compliance with applicable laws and regulations, including anti-money laundering and illicit finance statutes and rules.

“Based on the agencies’ current understanding and experience to date, the agencies believe that issuing or holding as principal cryptoassets that are issued, stored, or transferred on an open, public, and/or decentralised network, or similar system is highly likely to be inconsistent with safe and sound banking practices.

“Further, the agencies have significant safety and soundness concerns with business models that are concentrated in crypto-asset-related activities or have concentrated exposures to the cryptoasset sector.”

The agencies said they will keep the matter under review, as they engage and collaborate with other relevant authorities on cryptoasset activities.

The agencies have separately engaged banking organisations to fully discuss the issues and they encourage banks to ensure that crypto-asset-related activities can be performed safely, legally and in line with all applicable laws and regulations.

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Published January 05, 2023 at 7:59 am (Updated January 05, 2023 at 7:51 am)

Feds issue warning over cryptoasset risks

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