The Rise Of Cryptocurrency For Banks – Technology

On July 22, 2020, the Office of the Comptroller of the Currency
(the OCC) confirmed in Interpretive Letter #1170 the authority
of a national bank to provide cryptocurrency custody services.
Since that time, the OCC has issued other crypto-friendly guidance,
expanding the scope of permissible national bank activities with
cryptocurrencies. In January 2021 in Interpretive Letter #1174, the OCC confirmed
that a national bank may use new technologies, including
independent node verification networks (INVNs) and related
stablecoins, to carry out bank-permissible functions, such as
payment activities. On April 23, the OCC granted
preliminary conditional approval of a limited purpose
national trust bank charter for a bank that will provide services
only associated with digital assets. The OCC’s decisions may
lay the groundwork for greater bank engagement in cryptocurrency
activities, which have been subject to regulatory uncertainty.

As the OCC is the chartering authority for national banks, this
guidance is currently only applicable to those institutions.
However, the OCC, Federal Reserve, and Federal Deposit Insurance
Commission (FDIC) have indicated recently that they may work
together on a more coordinated regulatory approach to
cryptocurrency as it becomes an area of increasing public interest.
Significantly more uncertainty remains with respect to
state-chartered banks’ engagement in cryptocurrency activities,
and state-chartered banks will need to work closely with their
state banking regulators as the market for these activities further
grows and develops.

In this article, we discuss the parameters of OCC Interpretive
Letters #1170 and #1174, and the OCC’s April 23 conditional
approval. We also examine what may come next for federal and
state-chartered banks with respect to their involvement in the
cryptocurrency market.

Custody Services

Just as physical custodians hold property, such as securities,
on behalf of customers who for example may be other financial
institutions, institutional investors, and investment funds,
cryptocurrency custodians hold cryptographic access keys to units
of cryptocurrency. Since cryptocurrencies do not exist in any
physical form, a particular unit of cryptocurrency is assigned to a
party using a set of unique cryptographic keys. To access or
transfer cryptocurrency, a party must have access to these keys.
Additionally, if a third party obtains these keys, then they can
take (steal) the cryptocurrency. Consequently, losing or holding
keys in an unsecure manner can result in significant losses of
value to the owner of the cryptocurrency. A great deal of industry
effort has been spent on safekeeping for cryptocurrency.

Custodians hold cryptographic access keys in a
“wallet” that protects the keys from discovery by a third
party. Keys can be stored in “hot” wallets or
“cold” wallets. “Hot” wallets are connected to
the internet, while “cold” wallets are physical devices,
such as paper or hardware wallets stored in a physical vault. Hot
wallets allow for transactions, while cold wallets freeze the
cryptocurrency in place rather than allowing for transactions, and
are generally thought to provide better protection from

Before Interpretive Letter #1170 confirming that national banks
may custody cryptocurrency, significant regulatory uncertainty
existed around the permissible activities of banks with respect to
cryptocurrencies. This uncertainty resulted in most cryptocurrency
custody business being conducted by crypto-focused companies and
not by banks. Many potential institutional players in the
cryptocurrency markets had concerns regarding such providers and
seemed to prefer bank custodians.

In addition, the lack of bank custodians for cryptocurrency
prevented many investment funds from engaging in the cryptocurrency
market. Many investment funds are required by regulation to use a
qualified custodian to hold their property, and that custodian is
usually a bank, broker-dealer, or futures commission merchant.
Investment funds have largely been unable to find such qualified
custodians for the custody of cryptocurrency. By confirming
national banks’ authority to custody cryptocurrency, the OCC
helped open the door for investment funds to potentially invest in

This OCC guidance is similar in impact to recent U.S. Securities
and Exchange Commission (SEC) guidance for broker-dealers. In
December 2020, the SEC provided regulatory relief permitting
broker-dealers to custody digital asset securities, which are
digital assets meeting the definition of “securities”
under the federal securities laws, in certain circumstances. The
SEC also announced that while the current guidance is temporary, it
intends to develop a formal framework for custody of digital asset

The FDIC also recently signaled interest in custodianship of
digital assets by insured depository institutions. On May 17, the
FDIC issued a request for information and
 regarding insured depository institutions’
current and potential digital asset activities, including custodial
activities. This request may signal an attempt to align the
regulatory treatment of digital assets and offer greater certainty
to financial entities. The FDIC has requested comments by July

Taken together, the OCC, SEC, and FDIC actions seem intended to
create a level playing field for various types of regulated

Permissible Payment Activities

In Interpretive Letter #1174, the OCC concluded that national
banks may use new technologies, including INVNs and related
stablecoins, to perform functions that are permissible for banks,
most notably payment activities.

An INVN is a shared electronic database that enables copies of
the same information to be stored on multiple computers. A common
example of an INVN is a distributed ledger, where cryptocurrency
transactions are recorded.

A stablecoin is a type of cryptocurrency that is designed to
have a more stable value because its value is pegged to external
reference. In its letter, the OCC particularly focused its
discussion on stablecoins that are backed by a fiat
currency.1 These fiat-backed stablecoins can
typically be exchanged for one unit of the underlying fiat
currency, and therefore, can serve as a way to store, transfer,
transmit and exchange the value of the fiat currency.

Banks may be well positioned to facilitate payments using INVNs
and stablecoins since a core function of banks is to act as
financial intermediaries and to facilitate the flow of money and
credit in the economy. Banks possess the expertise to facilitate
the exchange of payments, and settle transactions, between parties.
This letter may open the door for national banks to use distributed
ledger technologies in the way they currently use traditional
financial networks, such as SWIFT, the Automated Clearing House,
and FedWire. Using INVNs to transmit stablecoins and other
cryptocurrencies may facilitate payments and support financial
transactions in a potentially cheaper, faster, and more efficient
manner than centralized payment systems.

Special Purpose National Bank Charter

The OCC further signaled its increasing acceptance of
cryptocurrency when it granted preliminary conditional approval of
the application to charter Paxos National Trust (Paxos) as a
limited purpose national trust bank in April. Paxos intends to
provide only services associated with digital assets, including
custody services; payment, exchange and other agent services; and
trading services.

The OCC’s decision indicates a move towards greater
integration of cryptocurrency businesses into the financial
regulatory framework. The possibility of being granted a federal
charter will likely streamline the businesses of cryptocurrency
entities that can obtain them. These entities will not have to
manage different states’ licensing requirements for
cryptocurrency businesses, which often implicate money transmission
regulations. Instead, they will be able to operate more seamlessly
on a nationwide basis.

Next Steps for Federal and State-Chartered Banks

The OCC’s decisions in the past year indicate an increasing
openness to allowing national banks to engage in cryptocurrency
businesses. In all cases, however, the OCC has said that a national
bank should consult with its OCC supervisors prior to engaging in
cryptocurrency custody and payment activities. While the OCC,
Federal Reserve, and FDIC have recently expressed plans to work
together more closely to align on cryptocurrency regulation, the
direction such regulation will take is uncertain. In his testimony
before the Committee on Financial Services in May, the newly
appointed Acting Comptroller of the Currency, Michael Hsu, stated
that he has requested a review of the “interpretive letters
and guidance regarding cryptocurrencies and digital assets,”
as well as the updates to the “framework for chartering
national banks and trust companies.”

Additionally, although the OCC’s letters and the recent
request for information by the FDIC indicate that there is momentum
building towards allowing banks to engage in cryptocurrency
activities, there is still no regulatory guidance for banks
regarding significant aspects of the cryptocurrency market.
Notably, there is no regulatory guidance regarding how a bank may
make cryptocurrency investments as principal or whether a bank may
make loans based on cryptocurrency collateral. There are also no
guidelines regarding how a bank might partner with a fintech
company to offer cryptocurrency products and services.

Significantly more uncertainty exists with respect to
state-chartered banks’ engagement in cryptocurrency activities.
While the OCC’s guidance may pave the way for state-chartered
banks to become more involved in cryptocurrency activities, we
expect that there will be meaningful engagement and coordination
among the various state banking regulators on this issue.
State-chartered banks will need to work with their state banking
regulators as the market for banks’ cryptocurrency activities
develops and expands.

While banks appear poised to operate in an expanding and
ever-more-in-demand cryptocurrency market, banks that decide to
engage in cryptocurrency activities, including custody and payment
activities, need to understand the risks and other regulatory
regimes associated with these activities. For national banks, the
OCC has said that banks engaging in permissible cryptocurrency
activities should “conduct a legal analysis to ensure the
activities will be conducted consistent with all applicable
laws,” including anti-money laundering, Bank Secrecy Act, and
consumer protection laws and regulations. The OCC also highlighted
that certain cryptocurrencies may be considered
“securities” for purposes of the federal securities laws,
and therefore may be subject to the OCC’s regulations on
recordkeeping and confirmation requirements for securities
transactions and the SEC’s federal securities laws.

Banks should also expect to invest significant resources to
improve their technology and security capabilities and systems
before engaging in cryptocurrency activities. As the OCC noted in
its guidance, a national bank must have sufficient technological
expertise to ensure that it can manage new technologies in a safe
and sound manner. In the context of custodying cryptocurrencies,
the OCC said that national banks should have effective information
security infrastructure and controls in place to mitigate hacking,
theft, and fraud. The OCC also emphasized that different
cryptocurrencies may have different technical characteristics,
which require risk management procedures specific to that
particular currency.


1 Fiat currency is paper money and coins that serves
as legal tender by decree, or fiat, of the government. Fiat
currency is inconvertible, meaning that it is not convertible into
nor backed by any commodity, such as gold or silver.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.