The recent instability in the digital asset sector has once again put the spotlight on the relationship between traditional financial institutions, or ‘TradFi’, and cryptocurrencies. Representatives from Circle and Coinbase have blamed the instability on the traditional financial sector, highlighting how the contagion was from TradFi to crypto rather than the other way around.
During a panel at South By Southwest, Caroline Hill, the senior director for global policy and regulatory strategy at Circle, gave the company’s first spontaneous public remarks on the situation since its flagship product, the USDC stablecoin, went on a rollercoaster ride over the weekend. Hill blamed the instability on the banking industry since the USDC stablecoin depegged from the dollar after three banks the company was working with failed in the five days.
The Silvergate Bank of La Jolla, California announced that it would start a self-liquidation process on Wednesday after suffering major losses related to dealings with the digital asset industry. The Silicon Valley Bank was closed on Friday while the Signature Bank in New York was closed on Sunday “to protect depositors,” according to a New York Department of Financial Services announcement. Hill also cited announcements made by the stablecoin giant over the weekend that aimed to provide transparency on USDC reserves that were being held.
The events of the past week are expected to further complicate relationships between banks and the digital asset industry. In the lead-up to the troubles and eventual demise of the Silvergate Bank, US bank regulators issued multiple warnings about exposure to digital assets. However, a massive run on deposits fuelled by a capital raise, jittery startup and venture capital customers led to the failure of Silicon Valley Bank.
Peter Kerstens, an adviser with the European Commission and a policymaker who was instrumental in the creation of the European Union’s comprehensive digital asset framework, acknowledged the complications that the events of the past week could have on future policy for the industry. “Many banks say they will have nothing to do with crypto,” Kerstens said. “Some regulators don’t want anything to do with crypto.”
Due to the fact that few banks are comfortable with the asset class, there is a limited number that do business with digital asset companies. This creates more risk for the crypto industry, argued Coinbase VP of Global Regulatory Policy Scott Bauguess. “Right now, there’s a lot of concentration of risk in the banking industry by crypto firms,” he said. With the operational challenges faced by two banks, Silvergate and Signature Bank, and the failure of Silicon Valley Bank, it means that two of the main US crypto banks were no longer available while a startup and venture capital-friendly bank failure threatened to have broader repercussions for the global tech industry, including crypto.
Bauguess further argued that TradFi has infected crypto, and it’s been just the opposite of concerns about crypto affecting the traditional banking sector. The current situation highlights the need for regulation for the digital asset sector. Hill emphasised that the crypto industry ultimately relies on a fractional banking industry that follows a fully-reserved model.
The recent instability in the digital asset sector due to the failure of traditional financial institutions is a cause of concern for the crypto industry. A lack of regulation and the reluctance of banks to work with digital asset companies creates a concentration of risk in the banking industry for crypto firms. Policy changes and regulatory frameworks are needed to ensure the stability and safety of the digital asset sector, and traditional financial institutions need to understand the value of cryptocurrencies and work together to achieve a mutually beneficial relationship.
