Regulators repeatedly raise concerns about whether crypto-assets can create financial stability risks for the economy as they become mainstream. Yesterday, the leaders of major ‘institutional crypto’ firms Custodia Bank, broker B2C2, and custody firms Fireblocks and Anchroage spoke about some of the settlement risks and legal uncertainties and how they might be addressed. They were talking at the Financial Times Crypto and Digital Assets Summit.
Settlement timing mismatch
Former Morgan Stanley banker Caitlin Long said that “Bitcoin’s going to take a G-SIB (global systemically important bank) down at some point because they don’t understand that the settlement risk is so different between Bitcoin and traditional assets.” Long is the founder and CEO of Custodia Bank (formerly Avanti).
She was referring to how Bitcoin settles within minutes and transactions are irreversible. In contrast, sometimes cryptocurrency payments are made using fiat currency, and U.S. payments invariably clear the next day.
Unlike traditional finance, there’s no central counterparty, which means there’s counterparty risk. Hence, if settlement is made using fiat currency you potentially have the timing mismatch that Long referred to.
Max Boonen, founder at SBI-owned crypto brokerage B2C2, didn’t entirely agree about the extent of the credit risk. In his view, the average cryptocurrency transaction is quite small, and a $100 million transaction in the crypto sector would be considered “absolutely massive”. Given the crypto market is more retail focused, he sees the credit risks compared to the firms’ substantial capital bases as insignificant.
He pointed to the large sums raised by Anchorage and Fireblocks, with the latter pulling in more than $1 billion in venture capital. On the flip side, he believes there are bigger risks to retail investors with cryptocurrency exchanges.
The other key point is that in the peer-to-peer (p2p) environment, the majority of transactions are settled with stablecoins as atomic swaps or delivery versus payment, which removes the risk.
Stablecoins address the counterparty and timing difference risks, but they introduce others, such as liquidity risk. While better quality stablecoins such as USDC and Paxos primarily use Treasuries as backing assets, Long pointed out that if you need to sell the Treasuries, they settle the next day.
However, a stablecoin ideally needs to be redeemable instantly, especially in a run situation, which points to the need for a federal reserve account. Her firm, Custodia, has applied for a banking license to support a digital dollar product that she described as more like a cashier’s check than a stablecoin.
As an aside, it’s notable that BlackRock recently invested in Circle, the issuer of the USDC stablecoin, and plans to explore USDC for securities settlement.
The potential centralization risks of stablecoins were not mentioned, but what was discussed is that the onramps for the $50 billion USDC stablecoin are currently primarily through just two banks, Silvergate and Signature Bank.
However, Fireblocks CEO Michael Shaulov commented that BNY Mellon would be added to the list. The bank recently announced a deal with USDC issuer Circle, but as custodian of the backing assets, rather than onramp. Shaulov should know because Fireblocks’ technology is used by BNY Mellon, which is also an investor. We reached out to BNY Mellon for confirmation but did not receive a response in time for publication.
Legal risks – who has title?
Moving on to other risks, Shaulov noted that many institutions use multiple custodians to address financial and technology risks.
Another risk highlighted by Caitlin Long is that the BIS Basel Committee has not yet finalized the capital that needs to be set aside by banks under Basel III rules if they hold cryptocurrencies. That means big institutions don’t want to hold crypto on their balance sheets.
The final risk raised by Long was a legal one. It’s not the regulatory uncertainty around crypto that everyone talks about but legal certainty around the cleared title to a crypto-asset. There hasn’t been a lot of litigation in this area which means that judges don’t have a roadmap set by legal precedent.