The Breakdown - The Real Battle Behind Debanking and Operation Chokepoint

Starting point is 00:00:00 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. What's going on, guys? It is Wednesday, August 6th, and today we are talking about the latest in the battle against debanking. 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. All right, friends, we have another very Washington DC-ish day here on the breakdown, kicking off with the battle against debanking. The Wall Street Journal reports that President Trump is preparing to sign an executive order targeting financial institutions over the debanking of businesses and individuals. Notably, the White House policy focus is broader than just the crypto industry.

Starting point is 00:00:58 The order also deals with politically targeted debanking, which the Trump family claims they were directly affected by. A copy of the draft order obtained by the journal laid out a series of threats and puns. for banks that participated in the wave of debanking. It directs regulators to levy fines against institutions that removed customers for political reasons, alongside other enforcement action. Further, it orders an investigation of financial institutions to see if they violated the Equal Opportunity Act, antitrust laws, or consumer protection laws as a result of their debanking. The order also directs regulators to remove policies that may have contributed to debanking. Among those is the Small Business Administration being instructed to review their loan partner policies,

Starting point is 00:01:35 effectively pulling the guaranteed loans from banks viewed as participating in debanking. Finally, the order calls for some violations to be escalated to the Attorney General for more serious enforcement. Now, you might be thinking, didn't the Trump administration already put a stop to Operation Choke Point 2.0 several times? Why are they putting out another executive order? We've seen a series of policies out of the administration so far this year. The banking regulators have all removed reputational risk as a criteria during bank exams. Freedom of information requests made to the FDIC have unveiled a plethora of emails shining a light on the policy. And yet the policy shifts have generally acted to put a stop to debanking.

Starting point is 00:02:12 What there haven't been is a lot of actions taken to ensure we don't have to deal with Operation Chokepoint 3.0 the next time the White House changes hands. It sounds like that's the goal of this executive order, to impose consequences on the banks in an attempt to make sure this can never happen again. Interestingly, Caitlin Long of Custodia Bank suspects the administration is aiming at the wrong target, posting, wait what? They said Operation Chokepoint 2.0 and D-Banking were dead multiple times. Glad they're realizing the truth. But 90% of the cause was Warrenites at the federal bank regulators, not the banks themselves. So, this is aimed in the wrong direction. For the serious take on permanent reform, banker turned stablecoin expert Austin Campbell posted, I've testified in front of Congress about this, but the single most important fix is that our banking regulators need to be forced to write down

Starting point is 00:02:56 regulatory guidance. Nothing can be done to a bank without advanced delivery in writing. and that all such guidance must be made public on a 12-month trailing basis. Equally so, regulatory decisions must be able to be challenged in court, and both the bank and those impacted by a decision must have standing to challenge it. This is the real fix. Without this, it's just a matter of time until I'm writing threads about OCP 3.0 and OCP 4.0. And what Campbell hits on here is that Operation Choke Point wasn't a bank policy. Sure, there were some folks that were more enthusiastic about removing crypto folks or conservatives,

Starting point is 00:03:27 looking at you, my former Bank, Bank of America, but this was a regulatory directive first and foremost. The directive, however, wasn't necessarily legal. The FDIC settled lawsuits about the first iteration of Operation Chokepoint in 2019, acknowledging that discrimination based on industry was not appropriate. In settlement documents, the agency wrote, regulatory threats on due pressure, coercion, and intimidation designed to restrict access to financial services for lawful businesses

Starting point is 00:03:51 have no place at the FDIC. But that, of course, is exactly what we got just three years later. No part of Operation Chokepoint 2.0 was contained in written policy or clear guidelines. In most cases, it wasn't even spelled out directly in supervisory correspondence. Instead, the banking regulators carried out this policy through veiled threats and implicit demands, leaving the entire process very poorly defined. Campbell's point is that finding the banks without changing the culture of banking regulation does very little. If the FDIC had been forced to spell out their policies in black and white

Starting point is 00:04:20 and they knew they could be sued over them, Campbell believes that Operation Chokepoint 2.0 could never have taken place. We'll see exactly how the executive order addresses the problem when it's signed later in the week. But it's notable how much of a groundswell there is for more comprehensive regulatory reform. SEC Commissioner Hester Purse's speech that we covered on yesterday's show was all about the need to reform the Bank Secrecy Act. David Ibsen, the executive director of the Counter-Extremism Project, spoke out against debanking in the opinion pages of Hill earlier this week. He wrote, The tools we built decades ago are not suited to today's challenges. Without reform, the anti-money laundering regime will continue to fail in its most basic duty, distinguishing between

Starting point is 00:04:57 friend and foe. Calming optimistic that there seems to be a real appetite for change on debanking. Senate Banking Committee Chairman Tim Scott was on a media tour yesterday to discuss the issue. He's currently pushing a more comprehensive reform bill in the Senate and pledging to, as he put it, end this modern-day redlining. Now, moving over to the crypto-specific regulatory world, the crypto sprint is getting underway with new guidance from financial regulators. The SEC has published a staff policy statement that clarifies that certain liquid staking practices do not constitute a securities offering. Liquid staking refers to the process of depositing a token into a staking protocol and receiving a receipt token in return. Those derivative tokens called LSTs accrue the yield while also

Starting point is 00:05:36 being used in defy protocols. The clarification was very broad, exempting most popular liquid staking protocols from registration. For those working in defy, this clarity is a huge unlock. When trying to offer a defy service of some sort, it's almost always better to start with a liquid staking token than build on top. The incremental yield being offered in Defi doesn't make a whole lot of sense if you have to forfeit the native yield of staking. This has meant that many Defy Apps struggle to promote their services to the U.S. market. Mara Schmidt, the CEO of blockchain developer company, Alluvial said, Institutions can now confidently integrate LSTs into their products, which is sure to drive

Starting point is 00:06:08 new revenue streams, expand customer bases, and enable the creation of secondary markets for staked assets. The key point in the guidance is that operating a staking protocol and issuing LSTs is unlikely to fall foul of the Howey Test. The SEC's logic is that staking doesn't involve institutional management. It's only a technical service. That's the argument that Coinbase and others made during the SEC lawsuits where this issue was litigated. Cracken was the only exchange to settle and take a fine instead of fighting it out in court, leading to their chairman and founder Jesse Powell tweeting,

Starting point is 00:06:35 can I get a $30 million refund? Nate Garassi, president of Nova Diaz Wealth, commented that this is probably the, quote, last hurdle in order for the SEC to approve staking and spot ETHs. Today's episode of The Breaktown is brought to you exclusively by gray scale. Grayscale is almost certainly a name you know. They've been offering exposure to crypto for over a decade now and offer over 20 different crypto investment products, ranging from single asset to diversify to thematic exposure to crypto and the broader crypto industry. They have long been innovators at the intersection of Tradfai and Crypto, and one of the benefits

Starting point is 00:07:14 for a lot of us is that grayscale products are available right through your existing brokerage or IRA. Now, of course, investing involves risk, including possible loss of principle. For more information and important disclosures, visit grayscale.com. Go to grayscale.com to explore their full suite of crypto investment products and invest in your share of the future. The guidance drew significant pushback from the remnants of the anti-crypto army. SEC Commissioner Caroline Crenshaw wrote a response to the staff statement opening with, some things are better left unsaid. Crenshaw argued that the guidance, quote, only muddies the water, claiming that LSTs are only exempt. exempted from securities law if the numerous assumptions made in the statement hold.

Starting point is 00:07:53 Essentially that small deviations could leave staking protocols exposed. Crenshaw also noted that this statement doesn't bind future SECs, signing off with, the message should be clear. Caviot, liquid staker. That somewhat sinister commentary seems pretty odd. The SEC has now laid out the general principle and can start issuing no action letters for specific cases. Those letters do bind future SECs and can further clarify the policy on a case-by-case basis.

Starting point is 00:08:17 Hester Purse offered her own commentary on the staff statement, arguing that LSTs are no different to documents of title like warehouse receipts that can be issued when gold or agricultural goods are stored. Amanda Fisher, former SEC chief of staff and now financial policy head of better markets, had a far less restrained critique. She argued, the SEC's latest crypto giveaway is to bless the same type of rehypification that cratered Lehman Brothers, only in crypto it's worse because you can do it without any SEC or Fed oversight. Indeed, the claim is that liquid staking is more risky than Lehman Brothers activities in the lead-up to the GFC. Now, usually, we don't really include the view of better markets as they are almost always

Starting point is 00:08:51 written in bad faith. Aside from the hyperbole, Fisher actually hits on a lot of the concerns the industry had in circa 2022 when ETH staking was getting off the ground. She judges on restaking, hacks that remove the underlying asset, and long wait times for unstaking as concerns. The core idea is that deviations between the price of a native asset and its LSTA derivative are a big problem. This actually happened for a time in 2022, when Three Arrow's capital was liquidating their stake ETH but unlocks were not yet allowed. That caused a large DPEG that rattled the market even further. Now, though, a lot of these issues have since been solved purely through market forces. Multiple loops of restaking, for example, have never become an issue because the market discounts the resulting LST due to the added risk.

Starting point is 00:09:29 This underscores the problem with the typical arguments offered by better markets in the rest of the anti-crypto army, which is that we can have an intelligent conversation about the risk of staking systems without invoking Lehman Brothers every time re-hypothication is brought up. Kirst Perkins, the president of Coin Fund, wrote, This is nothing like Lehman Brothers, I know, because I was there. Liquid staking has risks, no doubt about it. But if there is fraud, manipulation, or abuse, it is the CFTC's duty to enforce, and they should do so. If you want to prevent the next Lehman Brothers, we need to have traditional markets update their technology.

Starting point is 00:09:59 With trillions coming on chain post-Genius Act, we will have two systems. One will rebalance 24-7. The other will take nights, weekends, and holidays off. It's always a liquidity mismatch that causes crises, and this will be caused by outdated legacy tech. It's time to upgrade the system. The age of crypto is upon us like it or not. There is no going back. Crypto lawyer Jason Gottlieb commented,

Starting point is 00:10:19 Respectfully, Amanda, this view is not correct, legally or technically. If blockchain-based rehypothecation were around in 2008, we would have not had the issues we did. And ironically, crypto fixes several problems we had back then. Austin Campbell was far less generous in his engagement, tweeting, On the topic of debunking factually incorrect takes, this thread from our friend Amanda Fisher at Bitter Markets hit my radar today. This is a mess.

Starting point is 00:10:40 It's a very long thread, but one highlight is this section. Liquid staking is the process of staking a token, receiving a receipt for it in the form of a liquid staking token. This is not re-hypothication. It could be re-hypothication if you then stake the stake in the stake in the stake of the liquid staking token and on and on to infinity. But you will note in the SEC statement they did not say all forms of liquid staking are allowed, just that certain types of arrangements, which in this case involve a single act of staking, are allowed. That is not re-hypothication. That's just staking. It's staking in specific getting a token back for it to track that interest. In many ways, the correct analogy here is

Starting point is 00:11:14 bonds trading with the coupon attached because now you have a token that includes staking rewards. That's not re-hypification. Now, we are already getting beyond the scope of this show, but the underlying point is that the SEC Staff Bulletin demonstrates a sophisticated understanding that we haven't seen before. They clearly understand how staking works and which type of staking should be given a regulatory free pass. Policy is now at the stage where we can, once again, have nuanced good faith discussions about which crypto systems design should be endorsed and which should be closely regulated and monitored. Essentially, the regulators are starting to, you know, regulate rather than just ban things. And that's what makes the commentary from better markets damaging.

Starting point is 00:11:50 These are clearly people who have a decent understanding of the risks and tradeoffs being made in crypto systems, and yet they still choose to make ad hominem arguments about Lehman Brothers. Perhaps it's more to expect that they can adapt with the times, but here we are. Something far less controversial was a second piece of SEC staff guidance around stablecoins. The guidance is a stopgap solution to change the accounting treatment of stablecoins, potentially with some fairly large implications. Stablecoins will now be treated as cash equivalence for entities that report to the SEC, similar to bank deposits and treasury bills. This treatment is limited to U.S. dollar stable coins that are fully backed and where companies have a right to redemption. In other words, Circle and

Starting point is 00:12:24 Paxos issued dollar stable coins will generally be included because any company can sign up for direct redemptions. But Tether probably isn't covered by this ruling because they don't redeem directly. As I said, this has some big immediate implications. Corporates can now include states. stablecoin holdings as cash on hand in financial statements, and investment firms can count stable coins towards their liquidity requirements. Other regulators will need to follow suit before stablecoins can be treated as cash equivalent at banks, and so while overall this is a low-hanging fruit kind of clarification, it absolutely further reinforces that stablecoins are getting integrated into the financial system. And that, my friends, is where we are going to close out today's

Starting point is 00:12:58 episode. Appreciate you listening as always, and until next time, be safe and take care of each other. Peace.

The Breakdown - The Real Battle Behind Debanking and Operation Chokepoint

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