The Breakdown - Python Politics Part 1: The US Government's Slow Squeeze on Crypto via the Banking System

Episode Date: February 10, 2023

Operation Choke Point was an Obama-era initiative that put political pressure on banks and financial institutions to deny service to out-of-favor industries. Something similar is happening again with intense pressure being exerted for banks not to service the crypto industry. On this first part of a two-episode special, NLW looks at what’s happening, as well as the key recent history of the Office of the Comptroller of the Currency, the U.S.’ main banking regulator.  CORRECTION NOTE: At the 4:18 mark, NLW states: “At present there are two outstanding applications for licenses to operate national trust banks from Anchorage and Paxos, and these applications appear likely to be rejected by the OCC.” This was a mis-statement. Anchorage Digital is the only operational OCC-chartered digital asset bank, with their charter was approved by the OCC in January 2021. Paxos and Protego are the outstanding applications. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Lusky/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.  

You'll notice something was missing from that list of actions, which changed the landscape for crypto banking. There was no legislation passed. There was no public consultation. For most of the actions, there was no due process whatsoever and nowhere to appeal the decisions. Government agencies simply decided to lean on the banking sector in an attempt to get them to shut the crypto industry out. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDesk. What's going on, guys? It is Thursday, February 9th, and today we are talking about the U.S.

government's slow squeeze on crypto via banks. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. There is a famous if apocryphal phrase, first they ignore you, then they laugh at you, then they fight you, and then you win. If you've been paying attention to crypto over the last few weeks, particularly the signals being sent to the industry from regulators, you may have gotten the distinct idea that we've entered into the then they fight you stage. On Tuesday, February 7th,

Castle Island Ventures, Nick Carter tweeted, I don't want to alarm, but since the turn of the year, a new Operation Choke Point-type operation began targeting the crypto space in the U.S. It is a well-coordinated effort to marginalize the industry and cut off its connectivity to the banking system, and it's working. Then last night, Wednesday, February 8th, Coinbase CEO Brian Armstrong lit the industry up with his tweet accusing the SEC of trying to get rid of retail staking in the U.S. All in all, I think this is a moment that really demands more context. So what we're going to do today, and I think this is going to end up being a two-parter,

is go through some key events, organizations, and personalities to try to better bring you up to speed on why it feels like there is a slow, bureaucrat-driven squeeze on the American crypto industry. Specifically, we're going to dig into the recent history of a key bank regulator in the United States, the Office of the Comptroller of the Currency. In order to understand why, one, the fear of banks as a vehicle for crypto-contagent to spread to the traditional system is rising, and consequently, two,

why cutting off access to banks is becoming one of crypto-opponents' key tools. And here before we get into the recent history, let's start with the quick 2023 timeline of the squeeze. It's important to note that the specific vector for this attack that's emerging is the U.S. banking system. Since the beginning of the year, there has been an arming escalation and actions taken against banks that work with crypto industry firms. On January 3rd, the Fed, the FDIC, and the OCC, released a joint statement on the risks to banks who engage with the industry. While it didn't explicitly ban banks from touching crypto, it strongly discouraged them from doing so, citing, quote, safety and soundness concerns.

Throughout January, the few banks that service crypto firms started to wind down their activity in the industry. This was punctuated by an announcement from Binance on January 21st that their banking partner signature bank was refusing to process swift payments for less than $100,000. On January 27th, the Federal Reserve denied Custodia Bank's application to gain access to the Federal Reserve system, while the Kansas City branch denied their application for a master account, which would have allowed them to use wholesale payment rails. On the same day, the Federal Reserve released a statement strongly discouraging banks from holding crypto assets as principle or issuing stable coins. It also laid out a new interpretation of the Federal Reserve Act, which allowed it to apply

this guidance to state chartered banks in a response to the rise of crypto-servicing special-purpose depository institutions in Wyoming, which is, of course, the charter granted to banks like custodia which custody crypto. Also, on that day, the National Economic Council issued a policy statement strongly discouraging banks from transacting with crypto assets or maintaining exposure to crypto depositors. On February 2nd, the DOJ announced an investigation into Silvergate Bank over their dealings with FTX and Alameda research. On February 6th, finance announced it would be suspending USD bank transfers to and from their offshore exchange on February 8th, stating that they are looking for another banking partner. On February 7th, the Fed's policy statement was formally

entered into the Federal Register, making it a final rule. At present, there are two outstanding applications for licenses to operate national trust banks from Anchorage and Paxos, and these applications appear likely to be rejected by the OCC. In the space of a few short weeks, gaining access to banking services has become significantly more difficult for crypto firms. This is to the point where industry insiders are reporting that many startups appear to be on the brink of simply giving up trying. Now, before we go further, it's worth at this point at least trying to help you understand why regulators would say what their real concern at the heart of all of these actions is. When you hear regulators, particularly antagonistic regulators, talk about the problems of crypto.

There are two very distinct categories of things they talk about. The first is consumer protection, and this actually makes a lot of the headlines. These are concerns about crypto scams and people getting ripped off and grandmothers buying risky things that were promised to be too good to be true. This is people buying unregistered securities without proper disclosures, etc., etc., etc. A lot of the crypto concern you see in the mainstream media falls into this category. But it absolutely pales in comparison to the second category of concern when it comes to regulators. Then that second category of concern is systemic risk.

Systemic risk refers to the idea that if something goes wrong in crypto, it could spill over into the traditional financial system. Ever since the global financial crisis and crash of 08, systemic risk has been the chief concern for U.S. regulators. That experience taught them that leverage anywhere can become contagion ever. Now, historically, the concern around crypto and systemic risk has been a vague one, generally mentioned without much detail. After Bill Huang's archa-goes crashed, crypto exposure on opaque hedge fund balance sheets was one area that some regulators started to discuss. Although, of course, there's probably a pretty compelling argument that the issue there isn't a particular asset class but the opacity of hedge fund holdings, but in any case, the concern about systemic

risk in crypto has definitely started to get more acute, and it's getting focused around the banking industry. So at this point, we returned to that list of happenings from earlier this year. You'll notice something was missing from that list of actions, which changed the landscape for crypto banking. There was no legislation passed. There was no public consultation. For most of the actions, there was no due process whatsoever and nowhere to appeal the decisions. Government agencies simply decided to lean on the banking sector in an attempt to get them to shut the crypto industry out. And this, I think, gets to one of the most important points and why it felt important to do this set of shows right now. We're not seeing, at least not right now, a thoughtful

in front of the camera's discussion about systemic risk, crypto, and the banking system. That is a completely reasonable conversation to have. Instead, what I believe we're seeing is unelected officials who have long had a bone to pick with crypto. And honestly, let's make that even stronger, who have long hated been threatened by and are deeply embittered about crypto, taking advantage of the collapse of FTX and its associated fallout to try to railroad the industry through subtle but clear pressure. They're creating a vice-like pincer and circling the access points and on and off-ramps of crypto, the goal of which is not some sort of flashy outright ban, which would involve, you know, a real political process with elected officials. Instead,

the goal is just to make it so difficult and risky to be involved with crypto that banks voluntarily reject the industry. And so with that in mind, let's turn to the analogy that Nick Carter used to compare what's going on now to the last time politicians leaned on the banking system as a mechanism for enacting policy outside of normal channels. In 2013, the Obama administration, who were also faced with the divided Congress, launched a banking crackdown known as Operation Choke Point. After seeing success in their policy to shut out the offshore online poker industry from banking services in previous years, the administration expanded the program, suggesting to the banking sector that they should rethink their relationship with other

industries viewed as unsavory or politically out of favor. The program began with the payday lending industry, but quickly escalated to include gun sales and adult entertainment. Ultimately, the operation expanded to 30 different industries. The original grounds of the operation was to crack down on banks that were facilitating fraud, judged by a high ratio of chargebacks and disputes. By the end of it, however, industries were being redlined based on nothing more than a risk of reputational harm. Indeed, often financial institutions were investigated without having experienced any losses whatsoever. Importantly, throughout all of Operation choke point, no law was passed to enable it. None of the industries that were squeezed out of banking services were illegal.

In this case, there wasn't even ever written guidance issued. Banks were simply warned of increased regulatory scrutiny if they didn't tow the line. When Obama left power, the program came to a formal close in 2017, but its effects have lingered. Many major banks continued to refuse service to controversial industries like firearms and fossil fuels. Banks continue to ascribe higher risk ratings to industries they think might draw criticism from the government of the day, even in the absence of any guidance. Market purists, of course, have reasons to see this as the government intervening in normal market processes in a way that is hugely anti-capitalist. There are others, though, who see governments as just one more type of market actor, and in their

view, exerting power to lean on the financial system as a completely legitimate, if perhaps not first choice, mechanism for driving what they see as important change. Alas, as is always the case with government overreach in a democratic system. One has to examine not just how an expansion of power is useful when your preferred group or party is in power, but how that power might be used when the other folks take power later. The obvious but still very useful example is guns and abortion. For those liberal supporters of something like Operation Chokehold who didn't at all mind there being more financial pressure on guns and firearms companies,

how might they feel if the same techniques were turned towards Planned Parenthood? Seen in that light, the tactics start to feel pretty undemocratic, regardless of who is deploying. them. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3, happening April 26th through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Emmerse yourself in all that blockchain technology has to offer creators, builders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths. Visit Consensus.com. coin desk.com or check the link in the show notes.

Chokepoint involved a range of regulators, but the lead antagonist was the Office of the Comptroller of the Currency. The OCC is a branch of the Treasury and is in charge of chartering and supervising national banks. Despite it being the regulator with maybe the least name recognition for crypto industry folks, the OCC plays a huge part of our story. Where we pick up that story is when Brian Brooks joined the Office of the Comptroller of the Currency in April 2020 as chief operating officer and first deputy. At the time, this was an extremely notable appointment in the crypto industry as the role Brooks left to head the OCC, who was chief legal officer of Coinbase. To have an executive from one of crypto's most important companies moved to the USA's chief

bank regulator seemed destined to be a boon to the industry, if only from the standpoint of having someone in power who actually understood the digital asset space. However, the move became even more significant when less than two months later on May 29th, the then comptroller of the currency stepped down, and Treasury Secretary Stephen Mnuchin appointed Brooks to the role. Now, careful observers who remember this might have a question at this point. Steve Mnuchin never seemed to be much of a fan of crypto. He continuously spoke out against Bitcoin and crypto throughout 2018 and 2019, saying, for example, that they pose a threat to national security. Mnuchin is widely assumed to have been behind and in fact maybe have

literally drafted then-President Donald Trump's tweet where he said, I am not a fan of Bitcoin and other cryptocurrencies, which are not money, and whose value is highly volatile and based on in air. Manuchin even used his lame duck period after Biden was elected to try to enact stringent new rules against crypto wallets. So what the hell was he doing hiring someone who seemed like such a crypto guy in the role of head bank regulator? Well, Coinbase was far from Brian Brooks' first rodeo, and many of his background qualifications gave him a great resume for the bank regulator job. Before joining Coinbase, he was the EVP, General Counsel and Corporate Secretary for Fannie Mae from 2014 to 2015. And before that, from 2011 to 2014, he was chief legal officer for

One West Bank. Now, One West has a pretty interesting history. In the wake of the global financial crisis between 2008 and 2012, absolute havoc was wreaked in the U.S. banking industry. During that time, 465 banks failed. One of those was independent National Mortgage Corporation, or the IndyMac Bank Bank. IndyMac at the time was the fourth largest bank run in U.S. history. And when a bank failed, the FDIC or Federal Deposit Insurance Corporation sold their assets. On March 19, 2009, a 7th of member group led by future Treasury Secretary Manuchin and including heavy hitter billionaires, including Michael Dell, John Paulson, George Soros, and Christopher Flowers, bought Indie Mac and rebuilt it as One West, which came out of the gate with 33 branches and billions in assets.

One West very quickly saw some pretty serious controversy. Almost as soon as the bank was rebranded, it began aggressive foreclosure proceedings on thousands of homeowners. In one case, a Long Island judge penalized One West and called their actions harsh, repugnant, shocking, and repulsive, although his decision was later reversed. The details actually don't matter, but the legacy of One West stuck with Stephen Mnuchin, who got branded with the nickname the Foreclosure King even after he sold One West to CIT Group in 2015. So now things are getting a little clearer. The Treasury Secretary had previously had a close working relationship with a guy who was certainly by most standards qualified to work as the main bank regulator. And to the extent that Brooks and Mnuchin

disagreed about crypto, that didn't stop Brooks from having an immediate impact at the OCC. So in April he joins, and by the end of May, he's acting director. First thing in June, the OCC issued an advance notice of public rulemaking, which is a way for the regulator to request information. The notice asked banks and other financial institutions to share what type of crypto-related activities they were involved in, as well as, quote, what are the barriers or obstacles, if any, to further adoption of crypto-related activities in the banking industry? Are the specific activities that should be addressed in regulatory guidance, including regulations? Separately, the advance notice also asked about the use of blockchains and DLT.

quote, what new payments technologies and processes should the OCC be aware of, and what are the potential implications of these technologies and processes for the banking industry? How are new payments technologies and processes facilitated or hindered by existing regulatory frameworks? As he was dropping these advanced notes, Brooks also proposed a federal payments charter for fintech companies that would preempt the melange of 50 different state-level money transmitter licenses that companies in the U.S. have to obtain. And his disposition towards the future was clear. In an interview around that time, he said, my job here is not to protect incumbents, and it's not to preserve the status quo. I'm not curating a history museum here. The job I have is to make sure the bank's charter is flexible

enough to maintain a safe, sound, strong American economy, and the shape of banking has to be flexible to accommodate. Still, it was in July where things really heated up. The OCC released a public letter on July 22nd, 2020, effectively stating that national chartered banks were now allowed to custody crypto for clients. This was a huge change. Previously, the only companies that had offered custody had been specialist companies who got state licenses to offer those services. Now Brooks OCC was saying any nationally regulated financial entity could get into that game. The note, quote, reaffirmed the OCC's position that national banks may provide permissible

banking services to any lawful business they choose, including cryptocurrency businesses, so long as they effectively manage the risks and comply with applicable law. And I think at this point, what you may be starting to understand is that part of the way that we have to see this clamp down via the banking industry is as a story of action and counterreaction. In September 2020, the next big move at the OCC was publishing fresh guidance on how banks and other federally regulated financial institutions could interact with Fiat backed stablecoins. Basically, they said, you can provide services to stable coin issuers. Quote, national banks and federal savings associations currently engage in stable coin-related

activities involving billions of dollars each day. This opinion provides greater regulatory certainty for banks within the federal banking system to provide those client services in a safe and sound manner. By now, Democrats in Congress were not happy. In November 2020, a group of six Democrats wrote a sharply worded letter that accused Brooks of all manner of things, that he was spending too much time on crypto during COVID, that he had no business bolstering crypto banking while millions were waiting for relief. Quote, arguably, the immediate needs of millions of at-risk individuals who have not yet received an economic stimulus check and or cannot deposit their funds in a bank, deserve greater attention than an effort to increase access to financial services in the banked community

via mobile phones. The Democrats also characterized Brooks's actions as unilateral and said that they could put, quote, the entire hierarchy of dollar-denominated financial assets at risk. Quote, the OCC plays an important role in providing stable forms of currency. However, the decisions of your agency have the potential to adversely affect banking and financial activities well beyond your jurisdiction. It might surprise you very little that this didn't really slow Brooks down. On November 20th, 2020, Brooks went directly after Operation Choke Point. Marco Santori, now the chief legal officer at Cracken, wrote that day, Breaking, U.S. officer of the comptroller of the currency proposes rule prohibiting banks

from discriminating against, quote, legal but disfavored customers like oil and gas biz, independent ATM operators, and, of course, crypto companies. Centauri goes on. Crypto-OGs know the single greatest impediment to widespread adoption has been and continues to be the lack of access to banking services. In its early days, Bitcoin was caught up in Operation Choke Point, and Crypto more broadly is still caught up today. Operation Choke Point is a long-standing effort by political powers to cripple the growth of industries that were perfectly legal, but that they found distasteful. Instead of getting Congress to pass a bill outlong the industry, they just got

regulators to make their own lives tough by leaning on the banks to shut down their accounts. First, it was adult industries, then non-bank financial services, then of course, Bitcoin companies and now crypto companies more broadly. End quote. Now, the OCC's proposal in the Federal Register didn't mention cryptocurrency by name, but proposed that large national banks would only be able to deny financial services to customers on the basis of quantitative risk-based standards established in advance. In other words, not in response to discrete political pressure. The proposal did explicitly mention Operation Choke Point and used a myriad of examples to explain why it's not the job of banks or bank regulators to make decisions about morals, ethics, and national security priorities.

Quote, neither the OCC nor banks are well equipped to balance risks unrelated to financial exposures, and the operations required to deliver financial services. For example, climate change is a real risk, but so is the risk of foreign wars caused in part by U.S. energy dependence and the risk of blackouts caused by energy shortages. Balancing these risks is the purview of Congress and the federal energy and environmental regulators. In other words, not financial regulators or institutions. In the same thread I referenced before, Santori said, this proposed rule reads like a basic bill of rights for bank customers, one that you'd be shocked to hear didn't already exist. Given the broad monopoly granted to banks today, we should be asking ourselves why on earth this bill of rights

doesn't already exist. So clearly political tension was rising around the OCC, Brooks, and these fundamental questions of the political role of the banking system. That was reaffirmed when, in December 2020, a group of the same Democrats who had written to Brooks introduced the Stablecoin tethering and bank licensing enforcement act, or Stable Act. The press release said digital currencies whose value is primarily pegged to or stabilized against the conventional currency like the dollar pose new regulatory challenges while also representing a growing source of the market, liquidity, and credit risk. The 18-page bill had a ton of different requirements for stable coin issuers, including requiring them to get a banking charter, approval from the Fed, approval from the FDIC, as well as

the issuer's specific state or federal bank regulator, requiring ongoing analyses of systemic risk, and much, much more. The stablecoin spaces, you might guess, had some concerns. Jeremy Aller from Circle said it would, quote, represent a huge step backwards. He went on at that time, an enormous amount of the innovation brought to the underbanked and small businesses has been driven by non-bank fintech companies, enforcing crypto, fintech, and blockchain companies into the enormous regulatory burdens of Federal Reserve and FDIC regulation and supervision is inconsistent with the goals of supporting innovation in the fair and inclusive delivery of payments that comes from stable coins. Now, I think for our purposes here, the details of the Stable Act are somewhat

less significant than the politics around it. It was clearly a strikeback against Brooks in the OCC, who is increasingly being seen as a Trojan horse for the crypto industry to infiltrate Washington, D.C. And maybe we'll stop here for today and pick up part two of our story of Python politics tomorrow. Thanks, thanks guys for listening. And until tomorrow, be safe and take care of each other. Peace.