On July 22, 2020, the Office of the Comptroller of the Currency (“OCC”) published an Interpretive Letter (the “Letter”) declaring that national banks and federal savings associations (collectively, “national banks”) may provide cryptocurrency-related custody and other services. The announcement marks a revolutionary moment for the cryptocurrency industry where, until now, custody has been provided by crypto-specialist firms, typically under a state trust license.
In the Letter the OCC notes that, although providing custody for cryptocurrencies differs in several respects from other custody activities, such services are a “modern form of … traditional bank activities.” As an example, there is no physical possession of cryptocurrencies. Instead, a national bank “holding” cryptocurrencies on behalf of a customer is actually taking possession of the cryptographic access keys to that unit of cryptocurrency, that is, private keys. According to the OCC, by providing these services, “banks can continue to fulfill the financial intermediation function they have historically played.”
Moreover, national banks’ crypto custody services may extend beyond passively holding private keys. As expressed by the OCC, the custody function is a gateway to providing a whole host of other cryptocurrency services that are appropriate for custody customers. National banks may also facilitate customers’ cryptocurrency and fiat currency exchange transactions, transaction settlement, trade execution, recording keeping, valuation, tax services, and reporting. Basically, national banks may become full service crypto‑banking providers. We note, however, that the Letter does not authorize national banks to open FDIC-insured deposit accounts denominated in cryptocurrencies.
The OCC cautions national banks that comprehensive control systems need to be in place to manage risks of this business. In addition, as part of its ordinary supervisory process, any national bank looking into conducting cryptocurrency custody services should consult with the OCC supervisors.
Furthermore, it should be noted that additional requirements may apply depending on the nature of the cryptocurrency being custodied. As the Letter notes, different cryptocurrencies may also be subject to different OCC regulations and guidance outside of the custody context, as well as non-OCC regulations. For example, cryptocurrencies that are considered “securities” for purposes of federal securities laws may be subject to the OCC’s regulations on recordkeeping and confirmation requirements for securities transactions, as well as securities laws and regulatory requirements overseen by the SEC and FINRA.
Importantly, the OCC is authorizing these services within the existing authorities that national banks possess. There is no new regulation or guideline or other new law that needs to be put into place before this authority can be relied upon.
The Party is Just Getting Started – Who’s invited?
National banks now need to decide how to enter this new line of business. The OCC notes that depending on their risk appetite and business model, national banks may offer to store copies of their customers’ private keys while permitting the customer to retain their own copy, while others may generate new private keys which would be held solely by the institution on behalf of the customer. National banks may provide these services in non-fiduciary capacity, meaning merely holding a customer’s private key and related records, or in a fiduciary capacity, such as an investment advisor, a trustee, an executor of a will, or any similar capacity in which the bank possesses investment discretion on behalf of the customer. Due to the undeveloped financial infrastructure presently available for cryptocurrency, custodying in a fiduciary capacity presents both major business opportunities for national banks as well as compliance and technology challenges.
In the past, money center banks have been cautious in dealing with cryptocurrency counterparties, in part due to the perception that the regulators held a skeptical view of the industry and would, at exam time, be tougher on such relationships. The OCC has tried to head this view off by specifically stating in the Letter that that national banks can work within any lawful business and that cryptocurrency custody actives constitute such a lawful business. We believe that this shift in a key regulator’s tone can have consequences also in other financial institutions who may now take a more positive attitude towards cryptocurrencies.
What about state-chartered banks? Because many state laws, New York included, have so-called “wildcard” statutes that permit state banks to conduct all the same activities as national banks, the Letter has broader application than just national banks. Nonetheless, the prudential conditions stated in the Letter demonstrate that banks will need to devote a serious effort to perform these services.
We expect that those few banks already servicing the cryptocurrency business will quickly move to take full advantage and expand their services. Larger banks with existing robust institutional custody businesses are likely to follow suit.
The Letter provides opportunities also for many foreign banks that have branches in the U.S. While most branches do not have trust powers, the OCC letter allows for non-trust related use of this express authority with respect to nonfiduciary custody services.
One of the roadblocks in the security token market has been the lack of “qualified custodians,” such as banks and broker‑dealers. Qualified custodians are important actors with respect to cryptocurrencies deemed to be securities under federal securities laws, such securities tokens, that require in certain cases the use of a qualified custodian for maintaining client funds and securities. Here again, national banks have an opportunity to play a role. We also expect that expanding the universe of qualified custodians will provide a necessary boost to the budding securities token market.
Frenemies’ Warming Relationship
Given that Brian Brooks, Acting Comptroller of the Currency and head of the OCC, hails from the virtual currency world, it is not a shock that the OCC would be supportive of the industry and as banks become more expert in the complexities of the cryptocurrency business we expect that this first step will presage a number of new bank and cryptocurrency opportunities.
The Letter may stand as a turning point in the notorious “frenemy” relationship between banks and cryptocurrency. Banks entering the industry full pelt could have two significant consequences. First, it is possible that more merchants and consumers will find a lower barrier to using cryptocurrencies in everyday transactions. Second, it may rebuff those prognosticators who have maintained that banks would be made obsolete and disintermediated by new cryptocurrency-related businesses and technologies. If you cannot beat them, join them.
We recommend that any institutions looking to take advantage of the Letter and its direct and indirect consequences carefully consider the new business opportunities available and be attentive to applicable laws, rules, and standards in this highly regulated area.