A Crypto-Bank Contagion Death Loop?

The volatility of a crypto winter and rising interest rates, which combined to upend FTX late last year can no longer be denied, or ignored.

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With apologies to Rudyard Kipling, when it comes to central banks and crypto, the idea was that never the twain shall meet. The rise of cryptocurrencies and decentralized financial systems brought with them the sacred promise to operate outside the traditional financial system. 

Yet the bankruptcy of Sam Bankman-Fried’s $32 billion crypto empire FTX – which led to the loss of billions of dollars of customer funds, some of which appear to have influenced U.S. elections and ended up directly in Bankman-Fried’s pocket – blew those assurances to high heaven. Now the latest banking crisis is finishing the job.

The volatility of a crypto winter and rising interest rates, which combined to upend FTX late last year, certainly went uncontained, and the subsequent contagion ravaged crypto exchanges, then financial institutions, like Silicon Valley Bank, Silvergate Bank and Signature Bank, all of which served the crypto community. No matter how much central banks and crypto maximalists despise each other, their linkages can no longer be denied, or ignored.

Barney Frank, a former congressman who served on the board of New York-based Signature Bank, took the observation one step further, highlighting not just a correlation, but direct causation when it came to FTX’s role in the failures. “I think, if it hadn’t been for FTX and the extreme nervousness about crypto, that this wouldn’t have happened,” Frank said. “That wasn’t something that could have been anticipated by regulators.”

If that is true, then it also means last year’s steady stream of crypto calamities, not just FTX, likely contributed to the cumulative mess U.S. regulators are grappling with today. But that doesn’t mean U.S. regulators are happy to clean it up. In a sign they are not interested in saving crypto’s billions, the U.S. Federal Deposit Insurance Corp. arranged a deal for Signature’s cash deposits to be assumed by Flagstar Bank, a subsidiary of New York Community Bank, with the glaring exception of its $4 billion of crypto company deposits. Those crypto businesses were forced to bank elsewhere.

Frank, who helped lead major regulatory reforms of the U.S. banking system in 2008 following the global financial crisis, said he believes the move to exclude crypto companies was “to send a message to get people away from crypto.”

That strategy could backfire, driving the $1 trillion crypto industry even further offshore, making it all the harder for regulators to keep watch over it, prevent fraud, or investigate criminal activity and money laundering. Which, one might reasonably argue, is exactly the opposite of what regulators are supposed to do. 

This article is from Power Corridor, which delivers propulsive insights on Wall Street and politics into your inbox every Wednesday and Friday. Subscribe here.