By Clayton J. Mitchell, CAMS, and Matthew A. Schell, CPA, CFA
Fintechs and banks face different — but closely related — challenges as they adapt their business operations to accommodate the growing popularity of digital assets, particularly crypto assets such as bitcoin and ether that function as mediums of exchange without the backing of a sovereign government.
As boards and executive teams sort through the various strategies available to them, a clear understanding of recent industry developments and regulatory guidance will enable fintechs to make more informed decisions about how they interact with the crypto world and the traditional banking system.
In 2020, several high-profile crypto-oriented fintechs began efforts to obtain specialty banking charters. Some have been granted limited trust charters by the Office of the Comptroller of the Currency (OCC); others have filed applications seeking full national commercial banking authority.
At the same time, banks are responding to recent OCC interpretive guidance that allows federally chartered banks to provide custodial and other services for crypto assets. While some earlier adopters have been in this space for years, a number of the nation’s largest banks, along with several regional and community institutions, have announced partnerships with fintechs to offer crypto products and services.
More Active Regulatory Involvement Coming
In addition to a changing competitive landscape, fintechs should anticipate that crypto asset activities might soon be subject to a more rigorous regulatory environment. For instance, U.S. Securities and Exchange Commission Chair Gary Gensler recently urged fintechs to prepare for, and ultimately embrace, such regulation.
“Right now, large parts of the field of crypto are sitting astride of — not operating within — regulatory frameworks,” he said, adding, “If this field is going to continue, or reach any of its potential to be a catalyst for change, we better bring it into public policy frameworks.” In a response to a letter from Sen. Elizabeth Warren (D-Mass.), Gensler wrote, “In my view, the legislative priority should center on crypto trading, lending, and DeFi [decentralized finance] platforms. Regulators would benefit from additional plenary authority to write rules for and attach guardrails to crypto trading and lending.”
Gensler is not alone in this opinion. In July, President Joseph Biden’s Working Group for Financial Markets announced it will be recommending new regulations governing stablecoins, a fast-growing type of digital asset with values pegged to a fiat currency or other commodity.
The U.S. Congress is also increasingly interested in crypto asset regulation. Several pending bills include provisions for new reporting rules governing these assets and decentralized financial networks as well as provisions to expand IRS tax and regulatory authority over crypto transactions.
Fintechs’ Strategic Choices
As fintech directors develop strategies for enhancing their crypto capabilities, an important first step is defining how they will interact with mainstream banking. In addition to needing banks to access the payments system, crypto-capable fintechs can draw on some of banks’ regulatory frameworks to help enhance their legitimacy and credibility with customers and other stakeholders.
Some fintechs have determined that the best way to achieve this objective is to obtain their own banking charters, which might enable them to offer services as a qualified custodian, access the Federal Reserve payment system, operate across state lines, gain access to stable deposit funding and provide additional offerings. But because a bank charter subjects a fintech to prudential regulatory requirements, other fintechs might prefer to establish working partnerships with existing banks.
Such an approach can offer fintechs a practical avenue for expanding their business models and deepening their crypto asset capabilities while also giving them access to their partner banks’ customer bases.
Both fintechs and banks should recognize that strategic partnerships involving crypto assets differ from conventional third-party relationships. Banks’ extensive regulatory responsibilities cannot be delegated to partners, so fintechs should be prepared to demonstrate that they can conform with their banking partners’ compliance protocols, from know-your-customer and anti-money laundering requirements to consumer protection and fair lending regulations, among others.
For fintechs with strong startup cultures that value innovation and risk taking , the transition into a prudential regulatory environment can be difficult. They should expect close monitoring and be prepared to dedicate the necessary technology and staffing resources.
Ultimately, the most successful crypto partnerships will be those in which the banking and fintech partners have aligned or complementary strategies, understand the governance and compliance requirements necessary to protect consumers and the banking system and embed an integrated risk management approach into their business processes and decision-making.
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