Office of the Comptroller of the Currency Issues First-Ever Federal Charters to Banks Specializing in Digital Assets

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2021 Issue One

Office of the Comptroller of the Currency Issues First-Ever Federal Charters to Banks Specializing in Digital Assets

By: Hayden Baker

During the first two months of 2021, the Office of the Comptroller of the Currency (OCC) issued the first-ever national trust charters to financial institutions specializing exclusively in digital assets.

As a result, the institutions, Visa-backed Anchorage Digital Bank and cryptocurrency custodian Protego, become the first digital asset firms afforded the benefits of recognition as a federal financial institution.[1] Interestingly, the OCC’s approval of the charter applications of both Anchorage and Protego comes on the heels of the late-2020 issuances by the state of Wyoming of novel state banking charters to digital asset firms. However, the OCC’s grant of a federal charter brings distinct new developments to the regulation and infrastructure of the digital asset markets. Explored in detail below is the impact of the OCC’s action to both retail customers as well as institutional players that have clients who invest in digital assets.

Uniformity in Regulation

From the perspective of financial institutions, the receipt of a federal charter provides substantially greater efficiency with regard to regulation and compliance. For example, a state chartered bank is subject to the laws, regulations, and licensures of the state of its charter. If, however, that bank desires to expand its operations to states beyond the state of its charter, the bank must follow the distinct rules and regulations of those additional states—which, for example, may involve the receipt of additional licenses. Conversely, state regulation is entirely preempted by federal law for banks holding a federal charter. The consequence of preemption is that the federally chartered institution may conduct its operations across state lines under one uniform set of federal rules and regulations. Accordingly, the OCC’s move to bring digital asset banks in line with the regulation of traditional institutions substantially increases the efficiency with which such banks may transact in the national markets (versus their state-chartered counterparts).

New Financial Products

One of the largest developments expected from the federal chartering of digital asset banks is the proliferation of new financial products and services. For example, one of the major topics in the realm of digital assets is their custody. Unlike fiat currencies, the custody of digital assets does not involve possession by the custodian of any tangible item. Instead, the custodian is charged with the “custody” of the asset-owner’s private key, which is used to access the owner’s digital asset “wallet.” In simplest terms, the key can be thought of as a private password that is used to access the owner’s digital assets. Unlike a password, however, the owner does not create the key and the key is generally impossible to commit to personal memory (due to length and complexity).[2] Further, if the key is lost, it is nearly impossible for the owner to regain access to its wallet. Accordingly, the safekeeping and security of the key is of paramount importance to any owner of digital assets.

Significant to the issue of custody, Anchorage and Protego’s newly granted federal charter should afford both firms the authority to offer sub-custodian services to traditional financial institutions. Consequently, a traditional financial institution such as Bank of America can now offer to its customers digital custody services through the use of Anchorage or Protego as a sub-custodian. While Bank of America is not currently itself in the business of offering custody of digital assets, the banking laws of the Unites States permit financial institutions to subcontract custody services to other federally chartered and qualified firms.

Additionally, with their respective federal charters, Anchorage and Protego should be each able to achieve status as a “qualified custodian” under the Investment Advisers Act of 1940 (Advisers Act)—a status that should prove helpful to SEC and Texas-registered investment advisers (RIAs). Specifically, under what is referred to as the “custody rule”, RIAs that hold “custody” of client funds or securities must maintain those assets with a qualified custodian.[3] An RIA is deemed to have “custody” of client funds or securities in a number of situations; among them is where an affiliate of the RIA is serving as a general partner or other control person of a hedge or other investment fund. Therefore, an RIA serving in such capacities to an investment fund seeking to invest in digital assets must locate an institution to serve as the qualified custodian of those assets.[4] Unsurprisingly, given the unique aspects of digital custody described above, institutions able to both hold custody of digital assets and satisfy the qualified custodian criteria are few and far between. Now, with specialized institutions capable to serve as the requisite qualified custodian, a substantial compliance/logistical barrier appears to be removed for funds that invest in digital assets.

More Institutional Participation

With the recent exponential jump in the value of digital assets such as Bitcoin, it should come as no surprise that institutional interest in digital assets saw a spike in 2020.[5] Even with seemingly mainstream acceptance of digital assets, however, the specter of regulation and compliance has historically left many institutional investors bearish on investment. But, with the federal chartering of Anchorage and Protego, there now exists in the market institutions able to effect transactions in digital assets while also subject to the same federal regulatory regime as traditional federal banks—regulations which include the OCC’s capital and liquidity requirements. Given this development, commentators have unsurprisingly predicted that 2021 will see even greater institutional participation in the digital-asset markets as the regulatory landscape becomes more robust and defined.[6] In line with this prediction, and consistent with the advances in digital asset custody detailed above, the asset management giant BlackRock announced recently in public filings that it green lighted the investment into Bitcoin futures by two of its sponsored funds. Accordingly, an interesting story to follow during the 2021 fiscal year will be the impact and scope of institutional participation in the digital asset industry, including whether that participation will continue to drive digital asset values.

Takeaways

Until very recently, how (or if) an ambitious sponsor of a digital asset hedge fund could satisfy the custody requirements of the Advisers Act was an open question with no apparent answer. This solution to the custody problem is just one practical example of the impact of the OCC’s new action on the digital asset industry. Beginning to disappear are the days of the regulatory “wild west”—days where institutions and customers were left to interpret for themselves which regulations (or even regulators) were applicable to their dealings within the digital asset markets. The new concept of a federally chartered digital asset bank, and the implications of that charter described above, is one more step towards both an efficient market for digital assets and the expansion of the many ways in which both institutions and customers can lawfully interact with those markets.

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[1] Note, that the OCC conditionally granted the national trust charters to Anchorage and Protego. The OCC’s conditions include entry by the firms into an operating agreement with the OCC that sets forth, among other things, capital and liquidity requirements and the OCC’s risk management expectations.

[2] The following is an example of a private key: E9873D79C6D87DC0FB6A5778633389F4453213303DA61F20BD67FC233AA33262.

[3] 17 CFR 275.206(4)-2.

[4] This section assumes the subject digital assets constitute funds or securities for purposes of the Advisers Act.

[5] See, e.g., Izabella Kaminska, 2020: The Year Bitcoin Went Institutional, Financial Times (Dec. 18, 2020), https://www.ft.com/content/0a6507e9-d3f4-4319-bffb-eb915260e388; Charles Bovaird, Bitcoin Flirts with $19,000 as Institutional Interest Grows, Forbes (Dec. 12, 2020), https://www.forbes.com/sites/cbovaird/2020/12/12/bitcoin-flirts-with-19000-as-institutional-interest-grows/?sh=7ae420b867c1.

[6] See, e.g., Todd Anderson, Crypto Custody Gets Shot in the Arm from Goldman & Anchorage, Lend Academy (Jan. 20, 2021), https://www.lendacademy.com/crypto-custody-gets-shot-in-the-arm-from-goldman-anchorage/ (noting that “the institutional push into crypto continues to accelerate with … Anchorage’s conditional [charter] approval.”); FinOps Report: Digital Asset Market 2021: The Year of the Institutional Investor?, Forefront Commc’n (Dec. 7, 2020) (opining that the “Office of the Comptroller of the Currency’s decision [ ] to let national banks act as digital asset custodians, was hailed as the badly needed impetus for institutional investment.”).

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