Time for reflection: How will FTX implosion impact crypto regulation?

Does the fall of FTX confirm the traditional banking sector's view on the crypto ecosystem? I think like many, we've been following the news closely, but the immediate reaction was, this is just the latest in a long stream of incidents that highlight the volatility and really just the fundamental deficiencies within the crypto markets. Can the legacy fiscal system and crypto coexist? Coming up on Word on the Block, Brian Labadeur, Vice President for Payments and Technology at the Independent Community Bankers of America, joins us to dive deep into those topics and a whole lot more.

The collapse of FTX, the third largest cryptocurrency exchange in November, has taken the industry by storm. Thousands of retail investors left unable to withdraw their funds from the bankrupt exchange. But the contagion did not stop there. Crypto lender BlockFi was forced to file for bankruptcy.

Many more have followed or on the precipice. And as other companies are battling with the contagion, regulators are undoubtedly taking note. Will this lead to more hawkish regulatory decisions? Perhaps even more importantly, could clear digital asset regulations have prevented FTX's meltdown?

And what type of regulatory framework can protect investors in the future? Well, today we talk to somebody with the perspective from the American community banking industry. Welcome to Word on the Block, the series that takes a deeper dive into blockchain and all the emerging technologies that shape our world at the intersection of business, politics and economy. It's what we cover right here on Forkast News.

I'm Forkast Editor-in-Chief Angie Lau. Well, today we are in conversation with Brian Lavender. He's the Vice President for Payments and Technology Policy at ICBA, or Independent Community Bankers Association of America. And Brian, I appreciate you joining us.

It's a very timely conversation. Oh, Angie, thank you for the invitation. I appreciate the opportunity to speak with you. Absolutely.

You've been part of the industry and, in fact, represent the traditional banking industry. I wonder your immediate reaction when you heard the news of FTX and subsequently what happened afterwards. I think like many, we've been following the news closely, but the immediate reaction was, this is just the latest in a long stream of incidents that highlight the volatility and really just the fundamental deficiencies within the crypto markets and the crypto ecosystem. And, you know, compared to the safety and security that a consumer can find with the community banking system, it just, you know, it highlights the issues.

When you say issues specifically, what do you mean by that? Well, I mean, the issues in terms of, again, the safety and security, you know, with a community bank, a consumer knows that they can deposit their assets, that those assets will be protected and that their community bank will provide the payments, products and solutions that they need. You know, but unfortunately for so many consumers who deposited their assets with various crypto providers, you know, they come to find that they're unable to withdraw them.

And now many of them are working their way through a bankruptcy process and it's uncertain whether consumers will ever be able to access their assets again. And that really is one of the biggest things. And I think the moment was really kind of a face, you know, face what all of the issues are. And it really was coming to a head.

Do you think that it really confirmed for you, coming from traditional industry and traditional banking industry, What you observed, perhaps wondered about for the crypto industry and what the public perception might be right now? Well, I mean, we've observed through numerous comment letters over the past year, significant concerns about the crypto ecosystem. In particular, these entities that present themselves as essentially shadow banks, presenting themselves as offering the same safety and security that they would find at their community bank.

But in fact, that's not the case at all. So, you know, I think in the wake of that, I think you will see some consumers maybe question interacting with that ecosystem. and hopefully instead turning to community banks again as their trusted provider of financial services. I think those are two very different things, though.

With the community bank, there is obviously participating in the kind of traditional finance way of getting yield, right? Certificates of deposit, treasury notes, and really traditional things. what crypto does and offer are two very different things. Do you think that these are either or or can both exist in your view?

You know, in terms of our perspective on this, you know, the crypto ecosystem, it is different. And to maintain the stability and the security of the financial system, it's really important for regulators to come up with a very clear regulatory framework. It provides very clear guidelines about which crypto asset activities are permissible, which ones are not permissible. I think that that's going to be really key going forward.

Did you see any early signs of possibly the FTX debacle, the implosion that we subsequently saw of FTX and Alameda Research's signs of trouble? Did you see any of that before it happened? No, I did not. Okay.

And a lot of people have started to refer to FTX's crash as crypto's Lehman Brothers moment, as the company's bankruptcy court filings revealed that FTX owed about $3.1 billion to its 50 of its largest creditors. And we now know to your point there are so many people around the world now having to line up and wait for this to really resolve itself in bankruptcy court But to your point, what measures could the industry have taken to prevent this type of event? Well, I think in some respects, it's a bit premature, right?

Because we're still learning more about the FTX case every day. And I'm sure that, you know, there'll be quite a long time before we know the full story. And I think it's important too to zoom out and remember that there's more going on, right? FTX was not the only incident in the crypto markets this year.

There's also the collapse of Terra Luna. There's also multiple DeFi hacks, Ronin Network, Wormhole, Wintermute, Beanstalk. I mean, there's been so many different incidents. And so, you know, I think that's important to keep in mind as we start to think about what sort of regulation needs to be in place, that this is much bigger than simply one company.

And that's something that we've repeatedly tried to raise, again, in our comment letters throughout the year. And specifically, what are you calling for? What do you think needs to happen in terms of bringing some clarity and clear guardrails to the industry? Well, we supported the President's Working Group determination that only banks should be able to issue stablecoins.

But we have also been long supporters of ongoing communication between the banking regulators, the OCC, the Fed, and the FDIC here domestically, with the markets regulators, the SEC and the CFTC. And we recognize that there's roles for each of them to play. And so going forward, it's really important for all of them to maintain, I think, good dialogue to be able to blaze that regulatory path. What do you think is missing as part of this dialogue?

Transparency of data, for example, understanding the dynamics of the market. What do you think still needs to, you know, for yourself and other policy observers and influencers and stakeholders, what do you think are the missing pieces still? I think the missing pieces are, again, just that clear regulatory framework. And that's something that we've asked regulators to provide.

If banks are going to participate in this, and there are a handful of community banks that are participating in crypto asset activities now, but if more are going to do so, you must have clear regulatory guidelines in place before. So I think that's really just the missing element. Is the appetite stinger after FTX? You know, it's really a very highly individualized decision.

There is no one-size-fits-all approach to cryptoassets. For some community banks, they see cryptoassets as solving some need for their consumer base, but others do not. So at this point, it's really it's a very highly individualized approach. Clear guardrails have been missing, at least on the U.

S. front. You mentioned that a number of your community banks are already starting to participate in crypto. I wonder what they're doing exactly and what's preventing them from getting deeper into the market and potentially for others to participate.

I think you need to start with the fundamental question of what does crypto provide to community banks that they cannot provide through some other means? I mean, you often hear about crypto proponents talking about crypto is solving for faster payments, providing a faster payment mechanism. But those already exist in the regulated banking system. Last year, the ACH network handled almost $73 trillion worth of payments, almost a billion in same-day ACH payments.

The RTP network is online. FedNow is going to come on next year. So, you know, I think for many community banks that are seeking to offer some sort of faster payment solution, they're prioritizing implementation for FedNow. Now, crypto, you know, compared to the products that are out in the marketplace today, I, you know, again, it just goes back to that fundamental question of can I provide something to their consumers that's not already met by something in the marketplace and within the regulated banking system?

You're absolutely right when it comes from the American perspective. There's no doubt this is the best served market in the world when it comes to financial products at very competitive prices. This is something that is a dominant benefit to working with the U.S.

in terms of trade and then also being able to participate within the country. And so if the world were to look at America as it does, as the gold standard, what kind of gold standard in terms of regulations and policy must be in place to protect not only consumers here, but frankly lay the groundwork and potentially framework to help other participants around the world for other jurisdictions to follow, to follow in terms of precedence or at least use as an important reference to their own jurisdictional policies?

I mean, I can really only speak to the American experience. You know, that's that's the one that I know. But recognizing, of course, that given its nature, cryptocurrency being unregulated as it is, you know, that really opens up the opportunity for, you know, different jurisdictions allowing for regulatory arbitrage. So we have encouraged domestic policymakers here to coordinate with their counterparts overseas because it really important to have that baseline framework And I know that there are some efforts underway with the Financial Stability Board to provide that baseline crypto asset framework and also one for global stable coins.

But there also needs to be, I think, some flexibility at the national level to be able to tailor regulations to suit their individual markets. You know, the echoes of FTX's collapse will undoubtedly have a ripple effect, not just on investors, but also, as you've said, regulators who are closely following the events unfold. You're one of the stakeholders, obviously, as you are participating in conversations here. We've recently seen the Department of Justice, the SEC, CFTC probing the failed exchange FTX.

What type of regulatory response do you anticipate from, you know, from obviously a traditional finance participant. Can you kind of clue us in as to what we can see from these regulators in response to what happened? You know, I'm not a regulator or part of the justice system. I think like others, we, you know, we recognize they have a role to play and we look forward to seeing the outcome of their investigations.

And so you totally, totally get that. You know, U.S. regulators are being asked for clear rules on crypto trading.

You've said that. Obviously, the lack of clarity is is what exposed retail investors to FTX, which is under the regulatory supervision of the Bahamas, which, you know, obviously is not part of the U.S. framework.

Would you say that regulators could have prevented FTX's collapse? Notably, FTX U.S. is regulated by U.

S. authorities. But if FTX were to exist here, do you think that it would have revealed itself sooner than later? I think it's still too early to speculate.

We still don't know the true cause of that collapse. So I think it's really important for regulators and for law enforcement to continue their work so that the industry can learn from not only this episode, but of course others as well. Brian, in your view, what do you think needs to happen next? Based on everything that you've observed of FTX and more, what do you think needs to happen next?

I think we will see regulators, policymakers take a much closer look at the risk presented by crypto assets, particularly with respect to the financial system. And we know that there are going to be more efforts to understand the risk presented by crypto assets. The Treasury Department should have a report next February on DeFi. I think there's also going to be another one on NFTs.

And I know that the FSB, the Financial Stability Board, recently said that they were going to make crypto assets a priority going into 2023. So I think it's just going to be much more of a laser focus on the risks and how they can be prevented or mitigated. When you talk amongst your constituents, and these are community banks across the U.S.

, have their views shifted in the wake of FTX's collapse and what's happened since? No, I don't think they've shifted. No. I mean, even before, again, you could see this from our comment letters and other policy papers that we've issued.

Community bankers, you know, they had concerns about this space before FTX, and those concerns remain even after FTX. So, you know, in that sense, our stance really hasn't changed. We've been at the forefront, I think, in terms of trying to raise alarms about the use of crypto assets by bad actors. I mean, we know that this year alone, hackers affiliated with North Korea have stolen more than a billion dollars worth of assets.

And that even after OFAC sanctioned tornado cash, people continue to use it. I mean, these are serious concerns. And I think that's why going forward, we're really urging policymakers to put national security and anti-crime measures at the forefront of any cryptocurrency policy. When you think when you say national security, there have been times when traditional finance and large banks have defied sanctions and things like that.

Do you so how how would you how would you define national security then for crypto in the same way that national security is defined for legacy financial institutions? I mean, I think that the hacks that really kind of underline those concerns, and we know, again, from OPAC and actors like that, that North Korea is behind a lot of this, as well as Russian ransomware gangs. I mean, either one of those is a significant threat to U.S.

national security. So I think at the end of the day, right, that just highlights our big concerns in this space. The hacks are definitely the criminals here. The system itself should be criminalized along with the people who are perpetrating the crime against it.

Just trying to understand that. No, we're trying to just, you know, as a part of this effort to come up with a clear regulatory framework, we just want that to be at the forefront, right? Keeping in mind that, again, this is much bigger than any single actor, that there are a lot of different ways in which bad actors can and have used crypto systems. And that should be at the forefront as policymakers start to think about the next steps forward.

Theoretically, in your view, can legacy financial institutions leverage blockchain-based payment networks? Is there room for crypto to improve our existing financial system? Does it have to be bifurcated? Can it be incorporated?

What are your thoughts? Well I mean here you know community banks you know they have to abide by what the regulators say And we have received guidance from the OCC the FDAC and the Federal Reserve They've all issued bulletins about crypto asset activity. And they all say that banks that are thinking about this have to notify their supervisor. So, you know, it's not really a question, right, of can they technically connect to these systems?

I mean, it's really at the end of the day, what do regulations allow for? And then does that solution actually meet any existing or future consumer need? Got it. And finally, you mentioned that you were among those who supported, and obviously there's divergent opinion here, but you are among those who support banks being able to issue stable coins or being the only ones who are able to issue stable coins.

Are the community banks in a position to issue stable coins? In what way would you use that stable coin for? Any progress so far there? What are your thoughts?

uh well i mean at this point you know we're still waiting for that uh regulatory clarity you know the pwg did issue that report and that was their their primary conclusion but you know for the time being there's still a real lack of clarity about what exactly is permissible including any activity related to stable coin issuance or even holding reserves so you know it just goes back to there needs to be a clear framework in place for really all actors in this space. I mean, right now, stable coins drives 70 to 80 percent of transactions that we're seeing amongst cryptocurrencies, amongst crypto exchanges in decentralized finance.

if banks like yours or your community banks are the ones who are able to create and back the stable coins and bring it to market, is there an understanding of the way that it's going to be used? Or do you anticipate that you're going to create products that or enterprise network that also uses stable coins. What's the go-to market if banks were to issue stable coins? Do you understand the broader market that it's being used right now?

No, no. I mean, we do understand how it is used today. We know that there have been some thoughts about how stable coins could evolve in the future, maybe to be payment stable coins. I know that some proponents have said that Those could revolutionize cross-border payments or transactions like that.

We have to counterbalance, I think, those ideas against some other things that we know. We know that there are other efforts underway to enhance the speed of cross-border transactions. The RTP network is working with RT1 to allow for near instantaneous cross-border payments between the U.S.

and Europe. and even domestically too, right? There's concerns among some regulators about what the impact of payment stable coins could have if they continue to be offered by non-bank providers. I mean, the acting chair of the FDIC, he spoke about this just a few weeks ago, talking about the potential for payment stable coins to be highly disruptive to the community banking model in particular.

So, you know, this is a fast moving space and this is why it's so important for, one, bankers to be aware of what's going on, to study these technologies, to consider the risks and benefits. And then two, again, for there to be clear guidelines about what is permissible, what is not permissible. It's been a heck of a year for both the traditional markets and also for the decentralized markets as well. Crypto winter, as it were, but as it correlates also to the macro environment where we're seeing recessionary talk and definitely inflation hit home and hit wallets.

What's your prediction, Brian, for 2023? I have no doubt that payments will keep me busy. You know, this is quite the exciting sector in banking. There's no shortage of issues and new developments, whether it's in, you know, the quote unquote more traditional areas of like ACH or, you know, more exciting areas in terms of things like central bank digital currencies and instant payments.

So if I had to look into a crystal ball and think about what's going to be really big in 2023 domestically, I think it will be the launch of FedNow and the spread of instant payment capability across the U.S. as more community banks come online. And we know that crypto assets will continue to be a really big issue among policymakers.

and with, you know, those continuing efforts to research these issues, I expect that to add more fuel to the debate. So, you know, everything that we're talking about today, Angie, you know, I suspect we're going to be talking about six months. So maybe it felt like a reminder and check back in with someone and see, but, you know. I think we should have a standing date and check in in six months from now.

There's no doubt. I think this, I totally agree with you. I think this debate rages on. I think there is a really clear sense that there is value here in the technology.

Just how is it going to be used and implemented is for everyone else to fight over and fight about. Brian, I want to thank you so much for joining us. It was really good to understand from your very specific perspective and your perch there. And thank you for sharing thoughts from ICBA.

Really appreciate it. Oh, of course. Thank you, Angie. I really appreciate this opportunity to share our perspective.

It gives us a fuller picture. And thank you, everyone, for joining us on this latest episode of Word on the Block. I'm Angie Lau, Forecast Editor-in-Chief. Until the next time.