How the OCC Is Building Crypto America (and Saving Banks From Extinction)

Over the last 12 years, $1 trillion of value has appreciated into existence. It may be a little more or a little less tomorrow, give a few $100 billion. It may one day reach $10 trillion or $100 trillion or stay at $1 trillion forever. It may even go to $0. But regardless of all that, $1 trillion of value has indeed materialized and grown on blockchain-based financial networks since 2008. 

If you are a financial advisor or a trust company, you have missed out on $1 trillion in capital appreciation for your customers. Regardless of how we spin it, the core fact is that crypto assets have largely been un-advised. They have not been distributed by fiduciaries to the mass market. Instead, they have either (1) been directly owned by retail investors through crypto exchanges or decentralized apps or (2) been packaged and secured for safe handling by newly buy-side funds for the largest endowments and family offices in the world. That means retail and mass affluent investors are doing it for themselves at Coinbase or Binance or MetaMask.

This pattern joins a similar fact base for stock trading. Passive exchange-traded fund asset allocation assets have gone through the roof, in part because they are the choice of fee-based financial advisors and wire houses that now control about $10 trillion in assets under management. Selling a diversified, cheap asset allocation as your core investment is a stable market equilibrium. It is logic. It is statistics. It is math incarnate. Who will argue with Bill Sharpe?

But the animal spirits (John Maynard Keynes’ term for what drives investors) are emotion and feeling. The animal spirits are narrative and story. The animal spirits are inequity, wealth redistribution, billionaire witch hunts and revolution. The animal spirits are a cry for help from under a massive, endless pile of useless, unavoidable debt.

Instead of financial advisors or other CFAs guiding the retail market in good decision-making, a newsfeed of what’s popular has driven Apple, Google, Tesla and the other John Galt hallucinations to the stratosphere. Don’t get us wrong. We love the robot as much as the next fintech commentator. But it is clear to us that “the masses” are not being “advised.” And that the capital appreciation that matters – cementing the next trillion-dollar networks for global future generations in work yet to emerge – is misunderstood and misrepresented by most financial professionals to their clients.

Your clients won’t be your clients if crypto hits $10 trillion. As a reminder, total U.S. M1 (money supply) is about $7 trillion, the tech market caps on the Nasdaq during the dot-com bubble were $3 trillion, all gold ever mined is $8 trillion, global FX reserves are $10 trillion, total equities are around $100 trillion and all asset classes (including real estate, art and pork bellies) add up to $500 trillion. So the crazies are not crazy for being crazy.

The OCC white knight

It is in this context that we want you to understand the recent “interpretive letters” from the Office of the Comptroller of the Currency. But first the background.

American financial regulation is an alphabet soup and has grown out of politics and crises. It looks to the past, taking the fact patterns in mistakes underlying market crashes and banking crises to create executive structures that prevent those same mistakes happening again. Banks and investment advisers are under the supervision of different authorities. Banks can’t sell you stock (generally) and wealth managers can’t sell you bank accounts (generally); though, of course, they can if packaged up into a bank holding company. If you’re big, you can do anything.

The OCC is part of the U.S. Treasury Department. So is the Financial Crimes Enforcement Network (FinCEN) as well as the Internal Revenue Service. FinCEN wants to make sure you don’t launder money and that know your customer/ant-money laundering informaton is sufficiently captured to allow some amount of sovereign control and leverage over the moneys within the U.S. economy. 

While there are about 4,000 banks in the U.S., and about as many credit unions, some of them are federally chartered under the OCC and some of them are state chartered. You can see that the overall share of regulated banking entities at the federal level is hovering around 20% to 30%. This creates a novel tension and a couple of key dynamics.

First, there are large returns to scale in being a bank. Assets at the giant, federally regulated banks like Citi and JPMorgan Chase, are ballooning. Deposits at small, state-scale banks are falling. Second, fintechs (e.g., Square, SoFi) are naturally availing themselves to intra-state commerce by having a digital distribution footprint. They default to seeking federal charters as well. This is why the OCC has spent so many calories on defining special purpose fintech charters, and why the local community bodies hate it.

Being a national body, the OCC competes with other national regulators like the Financial Conduct Authority in the U.K. or the Monetary Authority in Singapore for the best financial regulatory “product.” It must attract global capital and global talent. It is counterparty to organizations that engage in such games. So you can think of the OCC’s crypto posture as either (1) resulting from the DNA of the organization or (2) the impact of third-party pressure on the organization.

The most credible critics suggesting option (2), i.e., regulatory capture by the industry, are Angela Walch and Tim Swanson. I do not want to mischaracterize their arguments, so I recommend you click through on the links. At the core, their concerns focus on shadow banking (i.e., “risky” non-banking banking) and the mismatches in goals between non-expert crypto developers and economic policy experts. The state-level authorities play a different game. They participate in inter-state competition (i.e., is New York better than Wyoming?) and try to minimize the influence of federal overreach. Economically larger states want to defend their current position, including defending their large banking constituents, while smaller states want to lower switching costs so new entrants choose to charter there. This is why Wyoming pioneered a banking charter with Caitlin Long, which has been granted to crypto exchange Kraken in September 2020 and is now available to others.

Now, let’s say you are the OCC. A state like Wyoming has set precedent – almost like the legalization of cannabis use or the adoption of other progressive social policies. You see China launching a central bank digital currency. You see the Ethereum ecosystem with $25 billion in stablecoin deposits. You see American companies building U.S. dollar-denominated digital asset products to compete globally. You see Facebook and Google trying to eat into your banking sector. How do you defend your turf? How do you start to lay down the road, brick by brick?

Where is the road going?

On July 22, 2020, the OCC published Interpretive Letter #1170, allowing national banks can custody crypto assets.

On Sept. 21, 2020, the OCC published Interpretive Letter #1172, on holding stablecoin reserves. National banks can hold stablecoin reserves for customers.

You can see the jigsaw puzzle coming together, even if the OCC’s letters are not the letter of the law. They can be challenged in court and they can be re-written by Congress through legislation. But they are today’s guidance for the financial industry, and in particular the national banking giants that hold $15 trillion of depository assets. Wells Fargo, Citigroup and JPMorgan are – by the stroke of the pen – crypto asset custodians, crypto payment companies and miners in blockchain networks.

What this means for the future

Allow us, for a moment, to raise our head above the trees to look at the forest.

Banks are quasi public-private institutions, attached to sovereign power. The central bank adjusts money supply to imperfectly target inflation, employment and growth. Banks create leverage of that money supply by lending out the money to consumers and businesses, which then circulates, gets deposited and lent out again. Narrow money of M1 today is about $6 trillion, while M2 is $19 trillion – about three times as large. This is a loose example of private-sector leverage that funds growth.

On the crypto side, a similar thing is happening in decentralized finance (DeFi). Instead of sovereign power, money is backed by software and the collateral it secures. In depositing ETH or other assets into Maker, you mint the DAI stablecoin. This can then be used to purchase other assets, which can be committed as collateral into lending markets like Aave or Compound to generate yield. Staked assets can then be further structured or wrapped into pools that earn market making fees on Yearn or elsewhere. Money is levered up and expands, creating leverage.

Bitcoin remains scarce, as does ether. Financial industries apply those scarce assets to economies for (hopefully productive) investment.

Back in the bank world, the banks must keep regulatory capital buffers to “ensure” the stability of the overall system. There is some percentage of assets committed against systemic collapse. To be a node in the traditional financial system, you must put capital aside to prevent a run on the bank and generate some sort of “trust” in the entire game. That capital yields a particular return, and must have a certain low risk profile. Bank of America alone has over $150 billion in such capital.

We think there is an analogy and lesson to be drawn here to crypto miners. Most next-generation crypto protocols use some staking, rather than proof-of-work mining, concepts. Whether you are a liquidity pool provider in DeFi or staking within Ethereum 2.0 to generate consensus, the committed capital is returning some rate of return for standing up a financial service. That capital is generating trust in the overall network, and a collateralization buffer in certain instances. While the analogy is not exact, we hear the rhyme in the poetry.

Banks should be large-scale miners or validators of blockchain networks. They already know how to do this. Many crypto natives will proclaim that this would imply a takeover by the system by the financial incumbents. That’s too simplistic. It would imply interoperability between existing economies and Web 3.0. It would bridge the global consumer makers into blockchain-based commerce.

And if you are paying attention, it has already happened with the OCC opening the door.