The Financial Crisis In Crypto. Some Believe It To Be A Conspiracy

Swan Bitcoin's corporate bank account was locked out by Citibank in October without prior notice or justification. The CEO of Swan, Cory Klippsten, received a physical check for the outstanding balance at his former residence as the only evidence of what had taken place.

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According to Klippsten, there was absolutely no notification. "We didn't receive any calls, emails, letters, or anything else. They simply turned it off.

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Swan was still able to pay its employees because it had a separate account at another bank, but Klippsten claims that this may have been a "existential threat" to a smaller company. An inquiry for feedback from Citibank received no response.

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The banking sector is essential to the cryptocurrency sector and has long been so. Without a banking partner, cryptocurrency businesses are unable to receive payments in dollars in exchange for services or tokens, or to pay their staff or suppliers. This has the unfortunate consequence that the effort to create a parallel financial system devoid of middlemen is contingent on a deal with those very intermediaries—the banks.

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Wall Street hasn't always been eager to partner with cryptocurrency businesses, which is why many in the sector have come to rely on just two US banks: Silvergate and Signature. By providing real-time payouts outside of regular business hours, these banks have become indispensable to crypto clients. Both banks have shut down in the last week: Silvergate due to an excessive exposure to the troubled cryptocurrency market, and Signature as a result of a liquidity issue brought on by an unexpected influx of withdrawals. This has put a lot of cryptocurrency firms, especially smaller ones, back where they started: unbanked and with few available options.

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According to William Quigley, founder of stablecoin issuer Tether, "banking is overwhelmingly the challenge for crypto businesses. "Many crypto users are excluded from financial services. It's a significant issue.

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Mainstream banks were frequently reluctant to cooperate with a sector they perceived as inherently dangerous when the crypto space started to expand in the early 2010s. Yet during the previous few years, the industry started to become more mainstream, which increased Wall Street's level of comfort. Large financial institutions like JPMorgan and BNY Mellon began banking cryptocurrency exchanges and allowing their customers to store and trade coins. Regulators monitored the industry, but aside from a few "policy sprints," they took very little action. 

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Later, in 2022, cryptocurrency saw a stunning crash. An estimated $60 billion was lost in May when the Terra-Luna stablecoin failed, setting off a domino effect that ultimately brought down cryptocurrency lender Celsius, investment company Three Arrows Capitals, and other companies. The collapse of the cryptocurrency exchange FTX, whose owner has now been charged with 12 criminal counts involving bank fraud, theft by deception, and money laundering, followed this in November.

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Regulators felt forced to ensure that it remained that way despite the fact that the consequences from the collapse of significant components of the crypto ecosystem didn't truly spread into the mainstream banking industry. The institutions in charge of maintaining the stability of the US banking system, the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC), asserted that cryptocurrency poses a "significant risk" for banks in a joint statement on January 3. Although the agencies made it clear that US banks are "neither forbidden nor discouraged" from servicing crypto firms, they stated that it is crucial that risks associated to the crypto-asset industry that cannot be managed or regulated do not migrate to the banking system.

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Banks have been further cautioned to minimize their exposure to cryptocurrency since the beginning of the year in pronouncements from regulators and the White House. The Federal Reserve announced in late January that it had rejected Custodia's requests to join the Federal Reserve System and open a master account, which would have allowed the company to compete on an equal footing with major national banks. Custodia is a state-chartered bank that provides cryptocurrency custody services.

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The two organizations that continued to be supportive of crypto, Silvergate and Signature, attracted almost all of the well-known people in the industry as well as many smaller ones. 

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First to fall was Silvergate. The collapse of FTX and its sister business Alameda Research, both of which were clients, caused customers to withdraw billions of dollars, and this contributed to the bank's difficulties. The bank made a wind-down announcement on March 8. According to reports, Silvergate is under investigation by the US Department of Justice for services rendered to FTX and Alameda.

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The circumstance at Signature was unique. To prevent the same concentration risk that harmed Silvergate, the bank had been working since December to diversify its clientele. The bank was taken over by the FDIC on March 12 as a result of a fatal run on deposits that appears to have been caused by its reputation as a cryptocurrency bank and the panic that followed Silicon Valley Bank's (SVB) failure.

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Barney Frank, a member of the Signature board and the former congressman in charge of US banking reforms following the 2008 financial crisis, claimed in an interview with Trade Algo on Sunday that the bank might have survived but that regulators "wanted to send a message to get folks away from crypto."

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A request for comment was not answered by the US Treasury. Both the Federal Reserve and the FDIC declined to make an official statement. The OCC's media relations manager, Stephanie Collins, acknowledged that the organization has no control over Silvergate or Signature but avoided talking about the coordination of US financial regulators. Nevertheless, the New York State Department of Financial Services, which gave Signature to the FDIC, claimed in a statement made available to Reuters that "the decisions made so over weekend had nothing to do with cryptocurrency."

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Nonetheless, there are also segments of the market that believe that regulators are biased against cryptocurrencies. Before Silvergate and Signature were closed, members of the cryptocurrency community, including the CEO of the US cryptocurrency exchange Kraken, were blaming a conspiracy and labeling it "Operation Choke Point 2.0," or a coordinated effort to isolate cryptocurrency from the financial system.

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Nic Carter, a general partner at the venture capital company Castle Island Ventures, created the phrase to describe a campaign the Obama administration allegedly used to drive banks into cutting relationships with questionable sectors including payday lending and pornography. 

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The Choke Point 2.0 theory's proponents claim that these actions represent a fresh attempt to regulate covertly—using influence over the banking industry to establish de facto policy without obtaining Congress's consent. "Most banks are currently terrified of accepting cryptocurrency, therefore the strategy has been successful without needing to be banned," claims Carter. "The goal is to accomplish as much as feasible without calling for the enactment of new laws."

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On March 9, a group of Republican senators, led by Tennessee's Bill Hagerty, wrote a letter to the financial authorities endorsing this interpretation. The letter said that banks have reconsidered their choice to offer financial services to the cryptocurrency sector as a result of the statements made by regulators. Operation Choke Point comes to mind while observing this concerted activity, which is unsettling.

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Operation Choke Point 2.0 is quite real, according to Caitlin Long, CEO of the bank that was rejected, Custodia. Many banks have drastically reduced their cryptocurrency activity, and many [crypto] businesses of all sizes are seeking for bank accounts.

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According to Long, Custodia has received a flood of inquiries from cryptocurrency companies that are looking for a bank partner since January, but without federal oversight it can only provide a small number of US dollar services. Due to the Fed's rejection of its membership application, Custodia is suing.

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The Choke Point hypothesis is not as widely accepted by others. Frances Copolla, an economist who has worked in managing risk for HSBC and the Royal Bank of Scotland, claims that she does not believe there has been a "organized onslaught against cryptocurrency" and that Silvergate and Signature's failure is a result of flaws in their business models. Talk of dishonest practices by regulators, according to corporate banking researcher Caleb Franzen of the research firm Cubic Analytics, is "just guesswork."

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The US banking system is currently experiencing a crypto crisis, whether by accident or deliberately.

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The collapse of Silvergate and Signature has forced the search for new banking partners by cryptocurrency companies. Circle Internet Finance made plans over the weekend to strengthen an existing alliance with BNY Mellon after news of Silvergate and SVB's vulnerability caused its USDC stablecoin to momentarily lose its peg to the dollar. Not everyone is safe though; cryptocurrency investment firms MaiCapital and Digital Asset Capital Management have moved their search for new banking partners overseas, and trading platform LedgerX has once again been forced to find a new bank after transferring from Silvergate to Signature. A request for comment was not answered by any of the companies.

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According to Carter, larger crypto companies are likely to be able to maintain their current accounts in the US because of the value they represent to banks, which means US citizens will still have access to cryptocurrency exchange. Smaller businesses, though, are "scrambling," he claims. According to Carter, the outcome is likely to be that some enterprises will relocate to nations with more benevolent regulatory frameworks, others will find it difficult to attract venture capital because it depends on having access to banks, and still others won't even get off the ground.

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The last two banks that provided real-time payments at any time of day or night, Silvergate and Signature, have gone out of business. As a result, the 24/7 cryptocurrency industry will need to adjust to working at a different speed. This prevents traders from placing wagers on markets outside of typical banking hours, which is expected to increase volatility.

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Klippsten is more optimistic about the chances of the businesses "orphaned" by Silvergate and Signature trying to find new banking partners and rejects the notion that US regulators have launched a systematic assault on the cryptocurrency industry, directed by "a man behind the curtain pulling the strings."

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Klippsten shares the desire of regulators to combat fraud in the cryptocurrency industry. He laments the fact that real cryptocurrency businesses would suffer collateral damage.

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The entire category is toxic, according to him; on average, it's a pile of dogshit since crypto is so shady and certain firms are conducted so poorly. Hence, asking a bank with thousands of accounts to distinguish between reputable crypto firms run by responsible adults [and bad ones] is difficult. We are confined to being treated similarly.

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