On November 3, 2021, Acting Comptroller of the Currency, Michael Hsu, gave remarks at the American Fintech Counsel's "Fintech Policy Summit 2021" and called for "leveling up banking and finance" to address regulatory issues and risks posed by "synthetic banking providers" in the fintech and crypto industry. "Crypto firms today are regulated at most only partially and selectively, with no single regulator having a comprehensive view of the firm as a whole."1Addressing the regulatory issues and risks in the fintech and crypto industry "requires a change in how regulatory agencies, including state regulators, interact" by adopting a coordinated strategy to develop a holistic view of how these fintech and crypto companies operate.2 "This warrants greater attention as crypto firms, especially the universals,3 get bigger, engage in a wider range of activities and risk-taking, and deepen their interconnectedness within the crypto ecosystem and with traditional finance."4
Hsu has served as the acting head of the Office of the Comptroller of the Currency (OCC) since May 2021. Hsu replaced Blake Paulson, who took office January 4, 2021 after the departure of Brian Brooks. Under Brooks' tenure at the OCC, the OCC made a number of policy decisions that established a bridge between traditional banking and the crypto industry. Upon assuming his role, Hsu initiated a review of the OCC bank charter applications and crypto-related interpretive letters to develop a strategy and create a regulatory perimeter for fintech firms.5 The results of Hsu's review of the OCC bank charter applications and crypto-related interpretive letters is complete and forthcoming, and will be aligned with the broader vision for the bank regulatory perimeter.
This alert discusses three Interpretive Letters—#1170, #1172, and #1174—issued by the OCC during Brooks' tenure. These Interpretive Letters cleared the path for cooperation between national banks and crypto firms. During the same period, the OCC also approved de novo charter applications submitted by several crypto firms.
Interpretive Letter #1170
Issued on July 22, 2020, Interpretive Letter #1170 affirms that national banks and federal savings associations may provide cryptocurrency custody services, "a modern form of these traditional bank activities."6 Analogizing cryptocurrency custody services to safekeeping and custody services for physical assets, the Letter explains that cryptocurrency custody services may include holding the unique cryptographic keys on behalf of customers, facilitating the customer's cryptocurrency and fiat currency exchange transactions, transaction settlement, trade execution, recordkeeping, valuation, tax services, reporting, and other appropriate services.7
Cryptocurrency owners need safe places to hold the unique cryptographic keys and banks are well positioned to provide the security need to custody the cryptographic keys. First, the underlying keys to cryptocurrency are irreplaceable if lost, resulting in losses to the owner. Second, banks may offer more secure storage solutions than other options. Third, investment advisors may wish to utilize national banks as custodians for their managed crypto assets.8
The OCC has recognized that as the financial industry becomes more centered on the digital experience, the requirement for banks to keep pace with technological advancements will grow. Banks are uniquely situated to offer cryptocurrency custody services.
Interpretive Letter #1172
Issued on September 21, 2020, Interpretive Letter #1172 confirms that national banks and federal savings associations may "hold stablecoin 'reserves' as a service to bank customers."9 Stablecoins are a generic term referring to a class of cryptocurrency that is designed to have a stable value.10 Cryptocurrencies are generally held in "wallets,"11 and there are two types of wallets: hosted12 and unhosted.13 Interpretive Letter #1172 covers only stablecoins held in hosted wallets, backed by a single fiat currency on a 1:1 basis, and redeemable for the underlying fiat currency noting that "reserves associated with stablecoins could entail significant liquidity risks" and "all banks must "manage liquidity risk with sophistication equal to the risks undertaken and complexity of exposures."
Interpretive Letter #1174
Issued on January 4, 2021 (the last day of Brooks' office), Interpretive Letter #1174 greenlights national banks and federal savings associations use of new crypto-related technologies, including independent node verification networks (INVNs) and related stablecoins, to facilitate payments and other bank-permissible activities. INVNs "consist of a shared electronic database where copies of the same information are stored on multiple computers."14 "INVN participants, known as nodes, typically validate transactions, store transaction history, and broadcast data to other nodes."15 Using INVNs represents a new means for banks to transmit payment instructions and validate payments, not as a centralized entity, but by serving as one of the nodes doing similar jobs in a decentralized network.16 Using stablecoins allows banks to capture the potential advantages associated with INVNs in a manner that retains the stability of fiat currency.17 INVNs can transfer stablecoins, which represent fiat currency on an INVN.18 "In this way, the stablecoin provides a means for fiat currency to have access to the payment rails of an INVN."19
The development of new technology "has led to a demand for banks to use INVNs to carry out their traditional functions."20 While technology has developed, a core function of national banks in using this new technology stays the same—transmit payment instructions and validate payments. To justify the transformation, the Letter specifically addresses the benefits of using INVNs. INVNs may be more resilient than other payment networks because the decentralized nature eliminates single points of failure.21 In addition, INVNs may be more trusted because information cannot be added to the network until multiple nodes confirm its validity, thereby prevent tampering or inaccurate additions.22 National banks may "validate, store, and record payment transactions by serving as a node on an INVN and us[ing] INVNs and related stablecoins to carry out other bank permissible payment activities…"
Conclusion and Prospect
In general, the interpretative letters reason that the cryptocurrency-related services are the modern equivalent of traditional activities and so it will not be easy for a new policy-maker to reverse course. However, on November 2, 2021, President Joe Biden officially nominated Saule Omarova to head the OCC. Omarova has criticized cryptocurrencies and advocated for the government to have a larger role in banking. The tone has changed with Acting Comptroller Hsu's ambition to modernize the regulatory perimeter and Omarova's nomination, and it may herald a shift in policy with tougher oversight and regulation of the fintech and cryptocurrency industries on the horizon.
For more information about navigating the banking, fintech, or cryptocurrency regulatory landscape, please contact Wilson Sonsini attorneys Josh Kaplan or Troy Jenkins.
[1] Michael Hsu, Acting Comptroller, Off. of the Comptroller of the Currency, Remarks at Fintech Policy Summit 2021, (Nov. 3, 2021).
[3] Id. at 3. Acting Comptroller Hsu describes “universal” as “offering everything from crypto custody to retail brokerage to market making to asset manage to prime brokerage.”
[6] Interpretive Letter #1170, at 6.
[9] Interpretive Letter #1172, at 1.
[11] Wallets are programs that store the cryptographic keys associated with a particular unit of cryptocurrency. Id., at 1, n.3.
[12] A hosted wallet is a wallet controlled by an identifiable third party. Id., at 1, n.3.
[13] An unhosted wallet is a wallet where the owner of a cryptocurrency maintains control of the cryptographic keys for accessing the cryptocurrency. Id., at 1, n.3.
[14] Interpretive Letter #1174, at 1. “One common form of an INVN is a distributed ledger. Cryptocurrency transactions are recorded on these ledgers.” Id.