The dilemma of debanking: Does the crypto industry need to break away from traditional finance?

Author: Iris, Liu Honglin

According to a report by Fox reporter Eleanor Terrett on January 25, the U.S. Senate Banking Committee announced that it will hold a hearing on February 5 (US time) to discuss the "debanization" of cryptocurrency companies by banks. Previously, the U.S. House Oversight and Government Reform Committee had already sent letters to the heads of several crypto companies, requesting an explanation on this issue.

In recent years, "de-banking" has gradually become a key feature of the crypto industry. From payment interruptions to financing bottlenecks, to the transformation of custodial services, crypto companies are also trying to "get rid of" traditional finance and complete decentralization at a time when traditional financial institutions are separated from the Web3 industry.

However, is debanking really an inevitable trend? Or is it just a short-term response to the pressure of traditional financial regulatory? More importantly, what impact does this trend have on the development prospects of the crypto industry?

Lawyer Mankun will explore in this article based on the current regulatory policies of representative countries and regions around the world.

What is debanking?

In the crypto industry, banks, as an important pillar of traditional financial institutions, have long been closely related to the development of the crypto industry. For example, in the early stage of the crypto industry, banks protected the flow of crypto assets and real currencies by providing fiat currency deposit channels; in the process of institutional development, banks also acted as custodians, providing asset security and credit endorsement for crypto companies. ;Even in some cutting-edge technology cooperation, banks have actively participated in blockchain application experiments to empower encryption technology.

However, in recent years, this partnership is undergoing subtle changes. As the regulatory environment continues to tighten, the relationship between banks and the crypto industry has begun to become increasingly tense.

On the one hand, the anonymity and cross-border liquidity in the crypto industry have put banks under higher compliance pressures, and the requirements of anti-money laundering (AML) and Knowledge Customer (KYC) regulations have forced banks to invest heavily when working with crypto companies. Resources, and these high compliance costs discourage some banks; on the other hand, the drastic fluctuations in crypto asset prices have further deepened banks' concerns about market risks. Traditional financial institutions believe that the high-risk attributes of the crypto industry may be stable. poses a threat.

In addition, the continued change in the policy environment has also intensified the bank's cautious attitude. Regulators in some countries have frequently put pressure on banks to limit or terminate services to crypto companies, while certain opaque projects and capital flows have triggered banks' vigilance about potential violations. More importantly, with the rise of technologies such as stablecoins and decentralized finance (DeFi), traditional banks still need to face competitive pressure from the crypto industry. This potential market threat has made some banks willing to cooperate with the crypto industry. Further decline.

Under the combined effect of this series of factors, some countries represented by the United States have experienced the phenomenon of "de-banking" in the crypto industry: payment channels are closed, accounts are frozen, traditional banks are gradually withdrawing from the crypto asset custody market, and some banks are even It is made clear that services will no longer be provided to crypto companies.

Interestingly, debanking is not entirely driven by banks unilaterally, and the crypto industry is also actively seeking alternatives to strive to reduce its dependence on traditional banks. In the payment field, stablecoins and on-chain payment protocols have gradually replaced bank accounts and payment networks, becoming the main payment tools in the crypto industry; in terms of custody services, native crypto companies, such as Fireblocks and Anchorage, can not only provide compliant custody Services also integrate technologies such as secure multi-party computing (MPC) into it to make up for the gap in traditional bank custody services; in terms of financing, the rise of the DeFi protocol allows crypto companies to directly raise funds through on-chain tools, completely bypassing the banking system limitations.

However, alternative solutions to the crypto industry are not entirely able to replace the key role of traditional banks.

The challenge of debanking

Although the trend of debanking seems to provide opportunities for the crypto industry to bypass traditional financial systems, lawyers Mankun believe that this trend also poses challenges that cannot be ignored. These challenges may not only hinder the development of the crypto industry, but may also weaken the industry's influence on traditional financial markets to a certain extent.

Crisis of trust

As a core institution in the traditional financial system, banks cannot be easily replaced by the crypto industry.

Transactions through bank accounts are often considered legal and compliant, and debanking operations that completely bypass banks can undermine public and institutions’ trust in the crypto industry. For example, although stablecoins can replace bank payment networks to a certain extent, if the reserve assets behind them cannot be escrowed by banks, the value support of stablecoins will be questioned.

In addition, in the absence of bank intervention, the crypto industry needs to bear higher compliance costs, such as independent establishment of anti-money laundering (AML) and understanding customer (KYC) systems, and the standardization and credibility of these systems still need to be strengthened. .

Asset security

The current alternatives in the crypto industry are hard to match with the experience and security capabilities of traditional banks in the field of asset custody.

Although some native crypto companies provide innovative hosting services, these services still face potential threats such as technical vulnerabilities, smart contract risks, and hacker attacks. More importantly, the credibility of custodial services may be challenged after debanking, especially for traditional institutional investors, the lack of bank-level protection may reduce their willingness to invest in crypto assets.

Financial quarantine

Debanking has gradually separated the payment network of the crypto industry from the traditional financial system. Although this improves the efficiency of on-chain payments, it can also lead to financial silos.

Payment and financing networks within the crypto industry may not be seamlessly connected with traditional financial markets, thus limiting the mainstreaming of crypto assets. For example, if some large multinational companies cannot connect with the crypto payment network through bank accounts, their willingness to use crypto assets as payment methods will also be reduced.

Regulatory pressure

Completely debanked operations may cause greater regulatory pressure.

In recent years, governments have continued to strengthen supervision of the crypto industry, and debanking may be seen as a strategy for the crypto industry to evade traditional financial regulation, which has led to more scrutiny and restrictions. For example, EU MiCA regulations require stablecoin issuers to store some of their reserve assets in banks to ensure value support, and the trend of debanization is directly contrary to this requirement. Similar policy contradictions may lead to intensifying friction between the crypto industry and regulators, and even trigger more restrictive policies.

Industry internalization

The debanking process is unbalanced, with large crypto companies often having more resources to seek alternatives, while small and medium-sized enterprises may face greater challenges. For example, large enterprises can establish internal compliance systems and talk directly to regulators, but small and medium-sized enterprises can fall into compliance dilemma due to lack of resources. In the long run, this imbalance may lead to further differentiation within the industry, aggravate the trend of resource concentration in leading enterprises, and be detrimental to the diversified development of the industry.

Globally regulated banks

In the above, attorney Mankun mentioned that the provisions of the EU MiCA Act regarding stablecoins require its issuers to comply with strict reserve requirements and store at least 30% of reserve assets in fiat currency in EU-authorized banks to ensure that the value of the stablecoin can always be linked to the underlying assets. Meanwhile, the MiCA Act also sets out compliance requirements for custodians and crypto service providers, requiring them to fulfill anti-money laundering (AML) and customer due diligence (KYC) obligations. Especially in the custody field, MiCA hopes to enhance asset security by authorizing custody banks, which to some extent offset the impact of the debanking trend.

This regulatory logic that re-bundles banks and the crypto industry not only appears in the EU, but also in the regulatory frameworks of other countries and regions such as Singapore and Hong Kong. In Singapore, the Payment Services Act (PSA) requires that digital payment tokens (DPT) service providers including stablecoins must obtain permission from the Monetary Authority of Singapore (MAS). This not only puts forward requirements on payment services and trading platforms, but also emphasizes the need for stablecoin issuers to work with local banks to ensure compliance with reserve management and payment clearing.

Similarly, Hong Kong's regulatory policies are continuing similar ideas. According to the latest guidance from the Securities and Futures Commission (SFC), stablecoin issuers are required to hold proof of assets of regulated banks or trust companies. In addition, Hong Kong has put forward higher requirements for exchanges and custodians, and effective internal control measures must be established to prevent funds from being abused while providing higher security guarantees for market participants. These requirements not only reflect the concern about user protection, but also show the regulatory authorities' importance to the indispensable role of banks in the compliance chain.

It can be seen that the trend of global crypto regulation does not fully support "debanking" whether in the EU, Asia or other regions. Instead, regulators in various countries are adopting regulatory design to incorporate banks into the core links of the crypto ecosystem, so as to reduce potential systemic risks while ensuring the development of the industry.

Summary of Lawyer Mankun

The debanization phenomenon reveals the crypto industry’s efforts to get rid of traditional financial constraints, and reflects the pain of the global financial system in the face of technological change.

The core role of traditional banks in payment clearing, asset custody and credit endorsement is still the basis that it is difficult for the crypto industry to completely replace. Although the crypto industry's technological innovation in the payment and financing field has shown great potential, insufficient trust, regulatory frictions and technical risks still restrict its further development.

Therefore, complete debanking is not a realistic and feasible path, and current debanking is more like a catalyst to promote the crypto industry to find a new balance between traditional finance, rather than a simple separation. More importantly, this phenomenon also provides an opportunity for reflection and adjustment for the global financial system. Debanking should not be seen as a unilateral experiment in the crypto industry, but rather the beginning of traditional finance and emerging technologies working together to explore future financial models.

As lawyer Mankun has always advocated, justice and regulation should not be contrary to technology, but should look for breakthroughs in integration. In the future, only by the joint drive of innovation and compliance can debankization not stop at differentiation and contradictions, but become the key driving force for building a new financial ecosystem. This is not only a key link in the self-evolution of the crypto industry, but also a historical node for the reshaping of the global financial order.

It is gratifying that as of writing, the United States hearing on Debanking has been successfully held, and the meeting has discussed the impact of bank account closures and financial service restrictions on businesses and individuals. During this period, several witnesses pointed out that regulators put pressure on banks, causing banks to cut off their business relationships with cryptocurrency-related companies, which not only affected the normal operation of the industry, but also weakened the United States' competitiveness in the global digital economy.

Meanwhile, the Federal Deposit Insurance Corporation (FDIC) released a 790-page document that acknowledged that regulatory measures in the crypto industry were too strict in the past and said it would re-evaluate the relevant policies. Travis Hill, an agent leader of FDIC, further pledged at the hearing that it will provide banks with clearer regulatory guidance to ensure they can participate in blockchain and cryptocurrency-related businesses within a legal and compliant framework.

The hearing and the FDIC's attitude adjustments send signals that U.S. regulators may loosen their policies on the crypto industry. However, this does not mean that the traditional financial system will open its doors to crypto companies completely, but is more like a recalibration of regulation between policy and market demand. The relationship between banks and the crypto industry may be ushering in an opportunity to ease, but real market changes still depend on the pace of supervision and execution.

But at least, the first step of fusion has already begun.