In remarks at the DC Fintech Week conference on October 11, 2022 and in a keynote address later the same day at a roundtable conducted by the Harvard Law School  Program on International Financial Systems, Acting Comptroller of the Currency Michael J. Hsu expressed concerns about risks to consumers and the financial system posed by crypto industry participants.

Acting Comptroller Hsu identified risks created by crypto companies’ use of bank-like terminology; integration and commingling of services both between banks and crypto firms, and within the crypto industry; and gaps in data necessary to understand risks posed by crypto-asset exposures at traditional banks.

As to terminology and marketing approaches used by crypto companies, Acting Comptroller Hsu warned that by using “skeuomorphism”, a design concept where a novel product or process is made to appear to be the same as a familiar product or process, “crypto has mimicked” familiar concepts associated with traditional financial products and services in order to suggest to the public that crypto products are analogous to banking products.  As an example, Mr. Hsu pointed to “crypto savings accounts” offered by crypto companies on their platforms.  These accounts promise consumers returns paid in additional units of crypto that are sometimes referred to as “yield” and quoted in terms of “APY,” thereby suggesting a stable, predictable return.  In some cases, consumers are assured that they can reclaim their assets at any time, even if the crypto company fails.

While Mr. Hsu did not refer to crypto companies’ claims as “misleading” or “deceptive”, his comments reflect his skepticism about approaches the crypto industry has used to draw consumers away from traditional banking relationships.  He noted that “[a]s many are now learning the hard way, the risks of these arrangements are materially different than their representations,” and cautioned that “[i]n these examples, skeuomorphism is not a bridge, but a disguise.  Using the familiar to introduce something novel can downplay or mask the risks involved and establish false expectations. In time, people get hurt.” In later remarks, Hsu reiterated the same theme: “A large segment of the crypto-asset industry continues to rely on hype and bootstrapping to grow.  Promises of innovation and inclusion often mask crypto’s promotion of a gold rush vibe…”.

As to integration and commingling concerns, Mr. Hsu cited fears not only about integrating crypto and traditional finance, but also about overreaching by crypto companies wishing to offer an increasingly broad range of services, such as: “digital wallets; buying and selling crypto; crypto custody; staking crypto for yield; crypto margin lending; trading crypto derivatives; holding fiat; borrowing and payments with a credit card; direct deposit of paychecks; facilitating peer to peer payments; issuing stablecoins; and creating, collecting, and connecting to NFTs.”  He expressed the view that until crypto matures and appropriate guardrails are put in place, limits should be placed on the scope of activities commingled within a single crypto firm and on the integration of crypto and traditional finance.

As to lack of availability of data necessary to identify, understand, and monitor risks posed by crypto activities, Mr. Hsu cited supervisory processes in place to monitor banks’ exposures to crypto and to gain visibility into their crypto activities, such as the requirement that institutions first obtain a supervisory non-objection before engaging in any of the crypto-asset activities that the OCC has determined to be permissible.  To receive a non-objection, an institution must demonstrate that it can conduct the proposed activity safely, soundly, and fairly. He noted that the FDIC and Federal Reserve have adopted a similar approach, helping to maintain a level playing field across the banking system.  He also cautioned that although this approach has been effective in monitoring banks’ crypto-related activities, further enhancements may be needed to track the risk of “cross-contagion.”  He indicated that the OCC is considering enhanced supervisory processes to more fully understand “the prevalence and scope of crypto-asset exposures and interconnectedness at our supervised institutions.”

Acting Comptroller Hsu went on to propose alternatives to impose supervision and, ultimately regulation, on the crypto industry, while not clearly identifying an optimal way to achieve this goal, or which regulator(s) should be responsible.  He suggested that gathering data from crypto firms and platforms on their activities with traditional financial institutions would give financial stability regulators a fuller picture, thereby enabling more effective surveillance of financial stability risks.  He also suggested that in the U.S., such monitoring could be conducted by the Office of Financial Research (OFR) and that in light of the borderless nature of crypto, consideration should be given to international coordination.

Mr. Hsu also discussed further considerations to be kept in mind with respect to “bringing crypto into the regulatory perimeter.”  He observed that “crypto participants (and fintechs generally) can choose from a menu of regulators and regulatory perimeters” and that “[t]he line between well-adapted regulation and unduly accommodative regulation can be a blurry one [with the possibility that] attracting crypto licensees and activities can be a sign that a regulator may have over-accommodated the industry.”  He indicated that “[c]ollaboration and coordination among financial regulators can serve as an effective mitigant to the risk of over-accommodation” and “is particularly important as long as crypto businesses are not subject to comprehensive supervision where a single authority has a line of sight into a firm’s aggregate activities.”

Mr. Hsu concluded his remarks by commenting that while he is skeptical of crypto’s real world utility and concerned about the risks it poses to consumers and the financial system, he is not prepared to “say with certainty that crypto is useless and should go away.”  He stated that his role as a bank regulator “is to ensure that the banking system is safe, sound, and fair—not to pick winners and losers among emerging technologies.”

We note that Mr. Hsu is not the only federal regulator who has expressed growing concerns about crypto.  Recent FDIC and CFPB issuances included warnings about crypto companies’ misleading advertising practices, as discussed in our recent blog post and podcast.