My political enemy’s enemy is my friend

Hello and welcome to the FT Cryptofinance newsletter. This week we’re taking a look at an outbreak of agreement in US politics.

Washington is a deeply divided place but politicians there have found some rare consensus around digital assets. What’s even stranger is that the crypto market isn’t on the defensive but cheering them on.

The issue uniting Congress is a seemingly minor rule change from the securities regulator that turned out to have large implications for the US financial services industry.

“The Securities and Exchange Commission is turning crypto into a political football and forcing the President to unnecessarily choose sides on an issue that matters to many Americans,” wrote Democrat congressman Wiley Nickel this week.

This is the backdrop to the US Senate’s vote on Thursday to nullify an obscure rule introduced without warning by the SEC in March 2022. The vote followed a similar one in the House of Representatives a few weeks ago.

Both legislative bodies have pushed back on the rule, which was buried in a memo the SEC normally reserved for guidance on dry accounting issues. It was intended to ensure crypto platforms holding assets for users upped their patchy standards.

But laid in Staff Accounting Bulletin #121 was a stick of dynamite. It stipulated that anyone holding crypto assets must treat them as both a liability and an asset on their balance sheet. Custodied assets are normally accounted as off-balance sheet items. Crypto was different, the SEC said.

This had a chilling effect, said Jason Allegrante, chief legal officer at Fireblocks, a digital infrastructure provider. Banks needed to hold more equity capital to cover their balance sheets and the capital charges were so large holding crypto becomes “economically unfeasible”.

Since then, anger from all quarters against the SEC and its chair, Gary Gensler, over SAB 121 has only grown. The fight isn’t won yet. Thursday’s Senate vote puts Congress on a potential collision course with the White House, as the Biden administration has promised to veto the bill.

To this distant observer, it’s hard to see why Democrats would put up a determined rearguard six months out from a presidential election. It seems a red rag to angry crypto supporters on the Republican side.

Even so, a crypto market used to open hostility from Washington sees this as a breakthrough. It’s the first crypto bill that has ever passed Congress and there are more on the way, including ones on stablecoins and crypto market structure.

Allegrante likens the momentum to the creation of securities laws (and the SEC itself) in the 1930s.

“The level of interest and sophistication in these discussions about blockchain technologies, what the use cases are, is really fascinating. We’re in the 1934 of digital asset regulation right now and I think it’s an incredibly exciting time for the industry.”

But the biggest winner, now as then, is arguably Wall Street. The most important market development this year is the US spot bitcoin exchange traded funds, which have grown faster than any other ETF launch in history.

Normally this would be great for traditional custodians like BNY Mellon and JPMorgan, but this time they’re nowhere because of SAB 121.

Instead, eight of the 11 new spot bitcoin ETFs, including BlackRock and Ark Invest, are safeguarding their coins at crypto exchange Coinbase — which is itself being sued by the SEC for operating as an unregistered exchange and broker.

Rather, SAB 121 shows that the interests of the crypto industry and traditional finance are becoming aligned as Wall Street steadily wraps its arms around the digital asset market.

As one crypto trading executive explained, repealing SAB 121 would “slowly chisel away at the regulatory overhang” that is stopping banks from building prime brokerage businesses for crypto. 

The failures of Silvergate and Signature Bank last year had a dramatic impact on the amount of liquidity in the market, he said.

Previously, professional traders could keep their assets at a bank and only move it into cryptocurrencies like stablecoins when needed. The owner of the money could continue to earn interest from it, rather than allowing it all to accrue to a stablecoin operator — until the disappearance of the two crypto-friendly lenders.

The crypto executive said banks could set up their crypto operations as “narrow banks”, which fully matched their assets and liabilities, so they could not lose money on the falling value of their assets or suffer a run.

“You would start to get the environment to build up these 24/7 banking networks. That will support the stablecoin world, tokenised money market world and frankly, crypto in general,” he noted.

But if crypto needs Wall Street to grow, the same can be applied in reverse. 

From the host of ETF holdings disclosures, investors large and small are increasingly comfortable with having some sort of exposure to bitcoin. But the impetus that drove the initial enthusiasm for spot bitcoin ETFs has ebbed.

The watershed moment for spot bitcoin ETFs will be when one of the big macro funds or sovereign wealth funds allocates a couple of percentage points of their portfolio to bitcoin, probably in place of gold. For that, they may prefer to leave their assets at a highly-regulated custodian bank. Coinbase’s early lead is not insurmountable.

To get there requires some guidelines from politicians, not just regulators. And one of the biggest political action committees in Washington now is Fairshake, which has raised $93mn to devote to pro-crypto issues — and funding opponents of anti-crypto candidates in election year. Suddenly there is a burning desire in Washington to get digital assets legislation through.

If crypto needs the banks to grow and make it more legitimate, traditional financial institutions are finding crypto’s lobbying menace very useful. “Politics is the art of the possible”, as Bismarck once said, and it can make friends of enemies.

What’s your take? Email me at philip.stafford@ft.com

Weekly highlights

• CME Group, the world’s largest futures exchange, is in discussions with interested market participants to launch bitcoin trading, as Wall Street money managers look to gain exposure to the cryptocurrency sector.

• The White House ordered a Chinese group that runs a crypto-mining operation in Wyoming to sell the land where it keeps its servers because the facility is next to a base that houses US nuclear ballistic missiles.

• Alexey Pertsev, a 31-year-old Russian, was sentenced to more than five years in a Dutch prison after a court ruled that he had developed and maintained Tornado Cash, a crypto mixing service that had laundered more than $2bn, usually from hacking operations.

Soundbite of the week: stay in your lane

Senator Cynthia Lummis was scathing about the SEC’s Gensler this week, pointing out that he didn’t have authority to regulate the banking industry.

“Maybe it’s because he’s committed to an ill-informed and unworkable fight against the digital asset industry at any cost. Unfortunately SAB 121 does nothing to protect consumers.”

Data mining:

Transactions spiked a month ago when bitcoin halved the fees paid to miners. Many crypto enthusiasts rushed to mark the 2024 halving with inscriptions attached to bitcoin.

But that sugar rush has worn off as quickly as it arrived. Analysts at Kaiko noted that miners were likely to soon feel the pressure of the slashed reward and be forced to sell bitcoin to cover their costs.

Cryptofinance is edited by Tommy Stubbington. To view previous editions of the newsletter click here. Your comments are welcome.