Nothing in rule or law prevents any of us from taking our wages and asking the dry cleaner to hold on to them for us because we always get our shirts back. Even if the dry cleaner is closer, we go to the bank because money really matters and we take for granted that any money we deposit at a bank is money we get back.
Federal Deposit Insurance Corp. (FDIC) insurance solves the information asymmetry that would otherwise make it hard for most of us to know to whom to entrust our funds, and rules on banks back up this federal promise. This all may seem obvious, but it proves a long-forgotten axiom — rules build deep, trusted markets. This we need to remember as battles wage over the Basel Committee on Banking Supervision’s proposal to apply tough safety-and-soundness standards to crypto-asset exposures.
The question of crypto-asset regulation is more than a struggle between rival interests. If crypto-assets are to become the digital currency necessary to power a digital economy, then they must be safe and sound for even the most vulnerable consumer. As my book “Engine of Inequality: The Fed and the Future of Wealth in America” details, a crypto-asset Wild West may well be an adventure for innovators, but it’s bad country for low, moderate, and middle-income consumers, small businesses and the broader financial system on which they and the rest of us depend.
Stripped to its essentials, Basel’s consultation creates two classes of crypto-assets. Those which are tokenized versions of other assets come under risk-based and leverage capital rules largely comparable to those now applied to the underlying asset. This makes sense if you think of an old-fashioned subway token — a coin-like slug that is the equivalent of a dollar you can readily exchange for a dollar if you don’t want to go to the Bronx. Although there are additional risk-management considerations, the difference between a tokenized-digital and a “real” asset under the new Basel rules is likely a capital and liquidity wash.
Digital assets more like stablecoins — cryptocurrencies backed by a basket of assets — get similar like-kind capital treatment, but tough standards also apply to ensure that the underlying real asset is always there and always worth what the digital representation would lead one to expect. This requirement could put bank-issued stablecoins at a disadvantage to other issuers — e.g., Facebook’s Diem — that need not adhere to rigorous capital or reserving requirements or that have balance sheets big enough to bear it.
But, unless these nonbanks also have access to the payment system — a big if thanks to the Fed’s pending proposal to open it up — banks are likely to retain a major and probably dominant position in critical liability and asset arenas. Think of the reserve requirement as essentially FDIC insurance and you’ll quickly see why.
Where Basel bites is in its treatment of crypto-assets that don’t meet specified tokenized or stablecoin criteria. These crypto-assets get the highest risk weighting bank regulators have yet created: 1,250 percent — or a more than dollar-for-dollar capital charged to any bank that holds more than Basel’s eight percent minimum, i.e., pretty much every U.S. bank.
But, there’s a good reason for this: see, for example, Mark CubanMark CubanOn The Money: Consumer prices jumped 5 percent annually in May | GOP senators say bipartisan group has infrastructure deal Mark Cuban: ProPublica ‘not being honest’ about taxes on wealthy Mark Cuban on Trump social media bans: It’s ‘the right thing to do’ MORE‘s sixty-to-zero crypto catastrophe. Supporting the hypothesis that crypto-asset holders will come to favor regulation, see also Cuban’s subsequent call for new crypto rules.
As we learned yet again in the aftermath of the great financial crisis, rules usually arise long after the need for them was all too evident. Whether it’s too late to prevent a crypto bubble remains to be seen. However, Basel is at least acting before one blows and surely ahead of still more widespread crypto-asset adventures by individual regulators and entities within and outside the regulatory perimeter tempted to play with fire. It’s also acting ahead of the point at which banks are left even farther behind the valuable efficiency and inclusion benefits digital assets clearly afford.
Crypto-assets are sometimes called “rat poison” because of the risks they pose to anyone not willing to be wildly speculative or desirous of hiding the proceeds of illicit transactions. While the crypto consultation raises at least as many questions as it answers, it’s a welcome foray by global regulators on to a field that clearly needs an umpire to prevent a bloody free-for-all.
Karen Petrou is managing partner at Federal Financial Analytics, Inc,. and author of “Engine of Inequality: The Fed and the Future of Wealth in America.” Follow her on Twitter: @KarenPetrou