WASHINGTON — Some cryptocurrency-related companies are using the Federal Deposit Insurance Corporation's bills of exchange regulations, passed in the final days of the Trump administration, to make deposits with banks more freely.
The company's strategy shows how cryptocurrency companies are more entrenched in the traditional banking system and how these companies can make deposits with banks with far fewer restrictions than a traditional depository organization. And combined with the recent fallout in the cryptocurrency industry, the exploitation of the alleged flaw is also fueling fears that brokerage deposits – sometimes referred to as “hot money” – are leaving the banking system in droves, critics say. .
Coinbase and Paxos are the largest crypto companies listed in the Federal Deposit Insurance Corporation's 12-page document on companies using the so-called "first target exemption," which allows them to circumvent deposit bridging barriers.
"The 12-page list of companies alleging fraud demonstrates its dangerous nature, with crypto companies like Coinbase and Paxos citing an exception," said Dennis Kelleher, president and CEO of Better Markets. "Just as water seeps through foundation cracks, cryptocurrency companies have been trying to get into the heart of the bank for years, and this appears to be one of the cracks."
Other big names in the crypto world also make an appearance on the list, although they are not exclusively in the field. These include MetaBank NA ( recently renamed Pathward NA ), whose sharp drop in deposits through mid-2021 reflects a sharp decline in what could be seen as post-Trump "temporary" changes, and fintechs working with cryptocurrencies. PayPal and chime.
Other PPE
We are talking about the Federal Deposit Insurance Ordinance of 2020 , which created a new basis for classifying traded deposits.
Negotiated deposits are deposits collected by a third party and deposited in bulk at the bank. Critics sometimes call these deposits "hot money" because investors can withdraw money to find better interest rates elsewhere.
This is exactly what happened after the savings and credit crisis, which bankrupted many small institutions. In response, regulators began erecting roadblocks to traded deposits, for example by prohibiting undercapitalized banks from accessing them or requiring such institutions to hold more cash to offset their exposure. Traded escrow accounts are also typically subject to more scrutiny from regulators and may require higher insurance premiums.
Therefore, the incentive not to treat deposits as an “intermediary” is high.
"It makes [traditional] deposits more attractive to banks," said Paul Clark, senior counsel at Seward & Kissel. "It really has to do with the stigma that the FDIC puts on the idea of negotiating a deposit."
The 2020 rule introduced and extended a set of criteria to a wider group of businesses to avoid these restrictions. The main purpose of the exemption is to give depositors a ride when their main relationship or business with the bank is not placing deposits.
These include cases where less than 25% of the broker's assets are deposited with custodians, as well as cases where "all client deposits placed with custodians are placed in trading accounts and no commission, no interest nor is any fee paid to the depositor".
Critics, including current FDIC Chairman Martin Grunberg, said at the time that the rule dangerously loosened the definition of what constituted brokerage and threatened the financial system.
"This regulatory change poses a significant risk to the banking system," he said in a 2020 statement . Under this amendment, a bank could rely on an unaffiliated third party for 100% of its deposits, none of which would be considered traded, and would ultimately prevent well-capitalized banks from receiving traded deposits.
Avoid the broker label
Therefore, by availing themselves of the primary purpose exemption, Coinbase and Paxos can place deposits provided to them by consumers with partner banks without the restrictions that apply to a traditional depositary intermediary.
“When you liquidate your cryptocurrency, say you have $10,000 in US fiat currency, the cryptocurrency company puts it in a bank and holds it for you until you want to buy more or get it back "Clark said. "The moment a third party comes and says, 'I want to deposit money in your bank, but I don't have any money', the bank will ask you to prove that they are not intermediaries ." One option is to have the FDIC file and get listed."
This means that these crypto companies can hold deposits with a cheaper bank, regardless of the capital level or stability of that bank, or without that bank paying more for deposit insurance or circumventing the regulatory review associated with holding interim deposits.
"Companies use a bank account as an in-and-out ramp to fulfill their primary purpose, which is to operate a cryptocurrency business or cryptocurrency exchange," said practice lead Lawrence Kaplan. of banking supervision of the system. To Paul Hastings.
Documents filed by Coinbase list "transaction facilitation" as the reason for the primary purpose exemption request, and its business is "cryptocurrency exchange."
Paxos Trust Co. LLC registration requires an exemption from the 25% threshold. The line of business is to "exchange, facilitate, regulate and sponsor stable digital assets".
Coinbase said the exemption was requested on behalf of the exchange by a financial institution it partners with and that "Coinbase's business model does not exploit intellectual property rights." A third-party deposit on behalf of Coinbase does not change the fact that the company has no deposit limit, a spokesperson confirmed.
Paxos did not respond to a request for comment.
Thus, some fear a massive outflow of bank deposits if, for example, one or both of these crypto companies fail or decide to suddenly liquidate these deposits.
This fear of a sudden default is present in all companies on the FDIC's PPE list, but this fear is much less theoretical in the case of cryptocurrency, which has seen greater volatility in recent months.
And even if a player withdraws their deposits, the results may not impact the wider markets. But in the event of a major seismic event, the fragility of these PSA deposits could aggravate a minor financial crisis.
Concerns about cryptocurrency companies and brokerage deposit rules are still theoretical and not shared by all experts.
Caplan said partnerships between crypto or fintech companies using the primary purpose exemption are fundamentally different and less risky than those regulators worried about before the savings and credit crisis.
"They had huge sums of money that could move in a second, which caused a liquidity crisis because traded deposits are so risky that third parties really control the liquidity," he said. “If the primary purpose is to sell cryptocurrency, the money flows in and out, and the bank knows exactly what comes in and what goes out. It's not the same risk as regular speculative money; it's very cheap and easy. The money some banks can keep."
Major crypto outages — FTX, Voyager, Celsius Network, Genesis, and BlockFi — aren't listed as exempt for primary purposes, and it appears broker deposits weren't part of Silvergate's post-collapse liquidity crunch by FTX .
However, this statement comes with a few caveats: the relationship between financial firms and crypto firms can be opaque, so it is always possible that any or all of these crypto firms may make deposits that are considered negotiated in pre-2020 settlements, but not t. ... They left.
Since the list was last published in late June, companies have also been able to notify the FDIC that they are applying for an exemption, although experts said it was difficult because most companies that had applied for the exemption soon had to fully comply. in 2021
The case of MetaBank and The Bancorp Bank
But there is plenty of evidence that Silvergate's cryptocurrency and fintech competitors - MetaBank NA and The Bancorp Bank - have a large share of deposits that don't qualify as brokers due to the exception of the primary objective.
Banks based in crypto-friendly South Dakota said traded deposits fell after complying with an updated FDIC rule that allowed traded deposits to be classified as non-traded. Both also have partnerships with some of the largest non-banks on the FDIC's list of top target exceptions, including Coinbase and PayPal.
A source with direct knowledge of how some cryptocurrency and fintech companies ended up on the exceptions list for significant reasons said MetaBank and The Bancorp are the chosen banks to facilitate these types of transactions. .
Of the two banks, MetaBank is the only one listed by the FDIC. The bank applied for an exemption under the "Permitted Businesses" section and said its line of business was "Custodial Accounts".
Notably, MetaBank joins Coinbase in the cryptocurrency exchange's direct deposit program , which allows consumers to deposit their paychecks directly into their Coinbase account. MetaBank issues "Coinbase Card".
As a result of the FDIC's updated brokered deposit rule , bank deposits "classified as brokered deposits have declined significantly."
by The Bancorp. Not listed with the FDIC, he acknowledges changes to FDIC rules governing his business and says "most" of the bank's deposits were previously classified as temporary deposits.
"In December 2020, the FDIC issued a decision that resulted in the reclassification of most of our deposits from traded deposits to non-traded deposits," the bank said. The bank's tax rate was reduced accordingly.
Bancorp Bank's business is based on fintech payments and collaboration. The bank provides mobile banking services for FDIC-listed Chime Financial Inc. It also provides banking services such as cards and savings accounts for PayPal cardholders and is also eligible for the primary purpose exemption, according to the FDIC.
The nature of the relationship between Bancorp Bank and its fintech partners is part of why at least one regulator said the rule changed in the first place.
“Under the previous status quo, the broad definition of deposit brokerage hindered bank-fintech partnerships by charging unnecessary fees and charges, especially when it came to app-based financial services that facilitate potential brokerage transactions. deposits for consumer savings accounts," the agent said. . Currency Control Brian Books. Brooks was named CEO of US cryptocurrency exchange Binance after retiring from OCC and is currently CEO of cryptocurrency firm Bitfury Group.
Other regulators, including Grunberg and current comptroller Michael Hsu, who have commented on the risks of bank-fintech partnerships in the past, may have a more rigorous view of how the initial exemption opened up deposit-taking to crypto companies. and fintech.
"If they meant all these people would come out of the lumber store and say, 'We want that too,' I don't know," Clark said.