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Financial regulatory lawyers know that regulation is one of the dullest subjects on the planet. Lawyers, who are not just geeks but recognizable as such from several hundred yards away, typically discuss certain incredibly boring facets of the profession, like regulatory capital requirements.

Occasionally, however, financial regulation has significant effects on the rest of the world that are only fully apparent in retrospect. For instance, the 2008 financial crisis touched everyone, but the average person didn’t really comprehend it until Hollywood productions like “The Big Short” or “Margin Call” digested the situation and could repeat the tale in an approachable manner.

The creators of cryptocurrency intended for it to be a technology of liberation: freedom from censorship by payment processors, freedom from the prying eyes of central and private banks; and freedom from the risk of settlement with shops.

This week, the president vetoed a congressional resolution known as “Staff Accounting Bulletin 121” or “SAB 121,” which is similar in complexity and potentially just as significant. The veto is not due to its potential to spark a financial crisis, which it won’t, but rather because it could lead to Donald Trump’s election to the presidency.

SAB 121, or agency interpretive guidance, states that banks filing regulatory reports with the SEC must list cryptocurrency assets such as Bitcoin or Ether as a liability on their balance sheets if they choose to “custody” them for third parties. Additionally, the bank must regularly update this debt to reflect changes in the value of the asset or assets under its control. The liability rises in proportion to the asset’s value.

Since the 2008 financial crisis, the state of bank balance sheets has been the top priority for federal regulators. To refresh your memory, the reason for that catastrophe was that banks bundled junk assets, such as bonds backed by subprime mortgages, and kept them marked at 100% of their face value even though their real value was far lower.

In terms of unrealized losses on low-interest loans that began to accumulate as the Fed raised rates to combat inflation, banks are acting exactly the same way now. Instead of addressing this issue, President Biden and the SEC, believing that Bitcoin is the root of the problem, have initiated a multiyear campaign of regulation and enforcement to stifle the US market.

But wait, you say, surely cryptocurrency should be subject to the same accounting regulations as any other asset listed on a bank’s balance sheet? Yes. However, banks rarely buy and sell cryptocurrency on their balance sheets. Banks will not profit from storing cryptocurrency themselves; instead, they will profit from collecting a set charge, such as 50 basis points per year, to protect it for third parties. This is because banks get revenue from creating and buying loans, not from cryptocurrency, which does not fluctuate in value. For accounting purposes, you should expect the bank to handle cryptocurrency more like a gold watch you inherited from your Uncle Bob and stored in a deposit box, rather than a T-Bill or an RMBS note the bank owns.

Because deposit liabilities are inexpensive for banks, whereas balance sheet liabilities are costly, there is an economic difference. In order to solve balance sheet issues, banks are required to store highly liquid assets, such as cash or US Treasury securities, and maintain them on hand in case the institution’s debts become due. This is known as “regulatory capital.” Banks generate money by lending out cash; therefore, the more cash they must hold back to maintain operations, the higher their capital cost and the less money they will make. The higher the asset, the poorer the bank’s balance sheet. Banks manage deposit liabilities differently, likely due to the constant availability of assets to meet demand. The organization can completely isolate customer funds from its trading activities by, for instance, holding the assets in an insolvency-remote manner. In this manner, a loss of the crypto assets due to an external event, like a natural disaster or a software glitch, won’t affect the bank as a whole.

If SAB 121 applies to the Uncle Bob gold watch in the safe deposit box, the bank must maintain both the watch and its cash value, and periodically mark the watch as idle and unused in a registered bank account. This kind of treating (off-balance sheet) cryptocurrency like (on-balance sheet) securities makes the expense of storing digital currencies unaffordable for any bank.

Given this, both parties in Congress and the U.S. Senate overwhelmingly supported a formal Resolution of Disapproval, which President Biden vetoed. Banks would have been able to treat custody agreements for cryptocurrencies as a deposit liability, as per the resolution. In turn, our legislature’s adoption of that bill appeared to be a hasty decision in response to a poll that revealed as early as May that as many as 20% of voters in swing states saw cryptocurrency as a crucial election issue.

If cryptocurrency is a problem this cycle, it’s only because Donald Trump made it that way. Examining the series of actions culminating in the veto of SAB 121, it is evident that the Trump campaign’s engagement in this matter was methodical, gradual, and circumspect. In a Fox News town hall-style forum later that month, the 45th president made his first positive reference to Bitcoin, following a flurry of back-office involvement with the business in early February. In an interview with CNBC on March 10, he proposed allowing customers to pay for collectible sneakers with Bitcoin, and the campaign made another mention after receiving no unfavorable backlash.

The industry correctly viewed these early signals as olive branches, and the campaign passed without incident. Then, on May 25, to thunderous applause, Trump boldly unveiled a comprehensive policy package to safeguard the cryptocurrency business, which included a pledge to lower early adopter of Bitcoin Ross Ulbricht’s prison term from two times life plus 45 years to time served. The sector enthusiastically embraced this suggestion.

Author: Blake Ambrose

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