Q: Over the last several months, it feels as if the digital assets industry has lost its momentum. There have been several protocol failures, security exploits, and bankruptcies that have created billions of dollars in losses to consumers and institutions alike and led us to a crisis of confidence. How do you think recent events and our current situation will impact the medium and long term growth of the industry?
The digital assets market has suffered a correction for sure, and oftentimes, when there is turbulence or a lack of liquidity in markets, the business models that are less resilient are tested and exposed. I think of this as a healthy correction in the market, which naturally shifts resources to the more fundamentally sound projects and also places a strong emphasis on the need for more robust risk and compliance controls. And there are calls for greater regulation and transparency.
I will note that while digital assets markets have definitely seen a significant downturn, McKinsey research shows that the percentage of consumers that are actively engaged with digital assets remained relatively flat at 12% of the overall US population in July 2022, versus 13% pre-market crash in March 2022. Additionally, 87% of consumers engaged in digital assets believe that recent market events have either improved or not changed their outlook for the industry.
At the institutional level, while there have been some layoffs at several digital assets firms, the traditional financial institutions continue to hire digital assets talent and advance their plans to support digital assets services.
Q: With the worst of the digital assets crisis hopefully behind us, and still strong consumer and institutional demand, what do you see as the major impediments for growth?
I think the single biggest challenge the industry is facing right now in the US is a lack of regulatory clarity at the Federal level. While states like New York and Wyoming have clear and transparent licensing and supervisory processes for digital assets activities, this is not the case at the Federal level. In terms of permissibility, only the OCC has clarified the digital assets activities that nationally licensed banks can support; they have also outlined a process to request non-objection. But they have not published any guidance on safety and soundness or consumer protection expectations. The Fed and the FDIC have both requested that banks inform them of their plans to launch digital assets businesses, but they have also not published any guidance on developing risk and compliance programs specific to digital assets.
There’s also a lot of uncertainty with capital markets regulation for digital assets. There’s still no guidance on roles and responsibilities between the CFTC and the SEC. We’re also missing some fundamental definitions that would allow the industry to grow, including the classifications of different digital assets as commodities or securities, the definition of Qualified Custody, and the definition of Good Control Location. These are foundational elements for traditional financial institutions and digital assets firms to continue to build and scale their businesses.
Q: What can banks and digital assets firms do to continue to advance their digital
assets businesses, despite the challenges?
There is certainly a need for greater regulatory clarity, and we see some indications that it is coming. For example, the Lummis Gillibrand Responsible Innovation Act is a comprehensive blueprint for all the issues that must be clarified. The President’s executive order on digital assets also calls for greater regulatory clarity and guidance.
But it’s likely that it will still be some time before we get the regulatory clarity needed, specifically on permissibility and safety and soundness standards. In order to deal with this uncertainty, we believe banks and digital assets firms need to engage with their regulators early and often. It’s important to clearly and transparently articulate the nature of the activities and inherent risks that they are managing or proposing. A comprehensive risk and compliance governance framework for digital assets should also be developed in support of these activities, as well as capital and liquidity plans.
A common phrase that regulators use when considering novel activities is “same activity, same risk, same rules.” In the absence of regulatory guidance for digital assets, banks, investment firms and digital assets firms will need to draw up their own interpretations on how to comply and develop risk and compliance standards to continue to grow their businesses.