Due to the rampant incidents of fraud in the crypto space, there has been a greater demand for guidance about digital assets.
This has prompted the Federal Reserve Board to issue a warning to member banks that it intends to prohibit a major portion of crypto banking activity.
The final rule
On Tuesday, a final rule was published in which the Federal Reserve’s Board of Governors provided an interpretation of the Federal Reserve Act, specifically section 9(13).
It provides guidance on how digital assets are to be used in the federal banking ecosystem. The section highlights the rules set forth for member banks by the Federal Reserve.
The member banks of the Federal Reserve comprise state level financial institutions that are able to meet the operational requirements associated with the Federal Reserve System.
There are two directives that have been issued in the rules that are in accordance with the existing laws of the Federal Reserve. Firstly, member banks will be prohibited from holding most crypto assets.
Secondly, those that wish to use dollar tokens would have to have certain security measures and also get former approval before they can use them for banking transactions.
It should be noted that both the rules also highlight the significant risks that are associated with the crypto space, including volatility, legal ambiguity, and fraud.
The rule states that a state member bank needs to have appropriate systems in place for monitoring activities associated with crypto-assets, or with distributed ledger technology in order to control risks.
It also talks about the various ways banks are inherently unable to ensure such security because of digital assets.
The Board also said that concerns about soundness and safety have bolstered this presumption.
The final rule also states that the volatility inherent in most decentralized digital assets does now allow financial firms to implement risk-management procedures that they use with other forms of capital.
Furthermore, there are also security risks because of the anonymity that is inherent in crypto transactions, particularly when distributed ledger technologies like blockchain are used.
While the Board asserted that there are security threats of using digital assets in the US banking system, it still suggested some avenues for their incorporation.
It was also noted in the final rule that issuing dollar tokens is also unsafe, as they are based on decentralized ledgers.
But, if member banks are able to demonstrate that they can use dollar tokens for safe banking, the Board would grant them approval.
These dollar denominated tokens are recognized as stablecoins in the market and they are different from traditional cryptocurrencies because they are pegged to fiat currencies, usually the US dollar.
Hence, there is a reduced risk of price volatility. But, the Board said that there are still operation and cybersecurity risks because dollar tokens also use distributed ledger software.
Therefore, this can lead to illicit financial activities. This decision paves way for another regulatory battle related to the crypto and digital assets industry.