What are ‘pause letters‘ according to the FDIC and how are they affecting crypto companies?

The FDIC’s ‘pause letters’ are essentially directives sent to banks, telling them to hold off on certain crypto-related activities. These letters were dispatched between 2022 and 2023 and included instructions to halt things like Bitcoin transactions done through third-party partnerships or advanced crypto services. The reasoning behind this action appears to be the FDIC’s desire to assess potential risks more thoroughly.

The ramifications for crypto companies have been substantial. Banks have become increasingly reluctant to work with crypto firms, likely due to fears of regulatory actions against them. This has created obstacles for U.S. crypto companies in securing essential banking services, hindering their growth and innovation. According to Paul Grewal, Coinbase’s Chief Legal Officer, these communications represent a broader strategy aimed at curtailing crypto initiatives, raising concerns about their effects on banks’ willingness to collaborate with crypto firms.

Is this tactic similar to ‘Operation Choke Point’?

Absolutely. The FDIC’s ‘pause letters’ bear a striking resemblance to the infamous ‘Operation Choke Point.’ With ‘Operation Choke Point,’ the FDIC, along with the Department of Justice, sought to derail industries identified as “high-risk”, such as payday lending and firearms sales, by pressuring banks to cut ties with them. The pressure was often applied without a clear legal basis, resulting in the termination of relationships with law-abiding merchants.

In a similar manner, the FDIC is using the ‘pause letters’ as an indirect tool to pressure banks into cutting services to crypto companies. The lack of transparency surrounding these letters and the blanket approach, affecting multiple banks, has spurred accusations of a coordinated effort to deny regulated entities the chance to serve the crypto community, mirroring the ideological targeting seen in ‘Operation Choke Point.’

What could the long-term consequences be for the U.S. crypto market?

The FDIC’s regulatory actions could have various long-term consequences for the U.S. crypto market:

1. Uncertainty and Stagnation: The absence of clear guidelines and comprehensive risk assessments may create uncertainty among financial institutions, potentially stalling the evolution and acceptance of crypto-related services.
2. Risk Management: Strong regulations intended to minimize risks might hinder banks from engaging in crypto activities, thereby restricting the integration of crypto assets into the traditional financial system.
3. Market Perception: The regulatory landscape may shape investor sentiment and market expansion, with overly cautious or vague regulations potentially diminishing the allure of crypto assets.
4. Innovation and Growth: The lack of supportive regulatory frameworks could stifle innovation and development in the crypto marketplace, as banks may hesitate to explore crypto avenues due to regulatory obscurity.

How do other nations find a balance between innovation and regulation in the crypto sector?

Countries have taken various approaches to strike a balance between cryptocurrency innovation and regulatory oversight:

1. Europe and the MiCA Regulation: In the European Union, the Markets in Crypto-Assets (MiCA) regulation has been established, aiming to create a uniform set of rules for EU member states. MiCA focuses on classifications of crypto assets, consumer protection, and registration of crypto service providers. This framework aims to foster innovation while ensuring regulation.

2. United Kingdom: The U.K. has enacted Anti-Money Laundering (AML) laws and Know Your Customer (KYC) requirements for crypto businesses. The government is also drafting proposals to categorize crypto as regulated products or services, fostering growth while minimizing systemic risks.

3. Japan: Japan requires all crypto exchanges to register with the Financial Services Agency (FSA) and establish stringent KYC and AML policies. They have recognized cryptocurrencies as legal property under the Payment Services Act and created the Japanese Virtual Currency Exchange Association (JVCEA) for industry governance.

4. Middle East and Dubai: Dubai, through the Virtual Assets Regulatory Authority (VARA), actively promotes a favorable ecosystem for cryptocurrency businesses. Its aim is to create regulations that bolster innovation and remain consumer-focused, positioning Dubai as a hub for crypto exchanges and enterprises.

5. Global Strategies and Regulatory Sandboxes: Nations like the United States, California, New York, Brazil, and Paraguay are making use of regulatory sandboxes and pilot projects to explore the impact of digital assets while foregoing immediate strict regulatory measures. This promotes financial inclusion and supports innovation but keeps regulatory oversight intact.

What legal considerations are there for contesting FDIC decisions?

Several legal frameworks and precedents provide grounds for challenging regulatory actions similar to the FDIC’s pause letters:

1. Administrative Procedure Act (APA): The FDIC’s actions can be challenged based on the APA which mandates that federal agencies must follow defined procedures for rule issuance. Critics argue that the FDIC’s pause letters may violate the APA by functioning as informal rules without undergoing the required notice and comment process.

2. Statute of Limitations and Timing of Challenges: The Supreme Court’s ruling in Corner Post v. Board of Governors of the Federal Reserve System indicates that challenges can be made within six years of any harm suffered by the plaintiff, rather than from the date the rule is finalized. This might allow new crypto firms to contest longstanding regulations.

3. Constitutional Grounds: Supreme Court cases, like Axon v. FTC, have clarified that respondents in federal administrative proceedings can assert constitutional challenges in federal court prior to exhausting administrative remedies. This could be applied against the FDIC’s actions on constitutional bases, like Five Amendment Due Process violations.

4. Increased Scrutiny of Agency Actions: Recent Supreme Court decisions indicate a readiness to closely scrutinize federal regulatory actions, suggesting that litigants might have improved chances of challenging perceived overreaches by federal agencies, including the FDIC’s pause letters.

5. Informal Rulemaking and Transparency Issues: Criticisms asserting that the FDIC’s pause letters constitute informal rulemaking without sufficient transparency align with the APA concerns. If these letters are deemed uniform, informal rules, they could be contested for breaching APA protocol.

In conclusion, the FDIC’s pause letters have profound implications for the crypto sector, drawing parallels to ‘Operation Choke Point’ and raising questions about the long-term effects on the U.S. crypto market. Various countries have found different ways to balance innovation with regulation, and legal precedents exist for challenging FDIC actions. The future of crypto regulation in the U.S. remains uncertain, as discussions continue about how to best foster innovation while ensuring regulatory frameworks.

The author does not own or have any interest in the securities discussed in the article.