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Published Thursday, December 8, 2022
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As Digital Assets Infiltrate the Banking Industry, New Risks Abound

The recent growth of cryptocurrency has greatly impacted the banking industry as we know it – enabling institutions to create new revenue streams, provide new services and expand their customer base. However, as banks welcome digital assets, they’re also faced with increased vulnerabilities such as fraud, cyber hacks and market manipulation, and the federal government has signaled that regulation is around the corner. In this uncharted territory of heightened risk and oversight, banks will need to consider how to safeguard against new and evolving exposures.

 

Cryptocurrency enters the mainstream

Cryptocurrencies like bitcoin and other digital assets were built as a way for consumers to complete digital transactions without a central authority. For that reason, they have been largely unregulated since their introduction, contributing to consumers losing billions of dollars and to lawsuits, enforcement actions and criminal prosecution.

 

In recent years, traditional financial institutions like Morgan Stanley and J.P. Morgan began offering private banking clients the opportunity to invest in several cryptocurrency funds. Soon after, Mastercard and Bakkt announced a partnership to allow consumers to buy, sell and hold digital assets through custodial wallets powered by the Bakkt platform. Additionally, numerous regional banks have joined multibank blockchains developed by fintech companies to facilitate instantaneous digital transactions between banks. Digital assets are increasing in complexity – in an environment with a history of little regulation – and banks should take steps to identify potential challenges that could impact their institution.

 

Litigation comes for digital assets

Traditional institutions that engage in this space should also consider the risk of costly litigation, especially when working with third-party vendors. Earlier this year, IRA Financial Trust lost $36 million of digital assets following a cyberattack. The digital assets were in the custody of Gemini, a virtual currency exchange, which is now being sued by IRA Financial Trust for allegedly failing to implement proper safeguards against the attack. The Gemini litigation is far from unique. In another case, a putative class of cryptocurrency holders filed suit against bZx DAO, a decentralized autonomous organization, and several other entities, alleging that the defendants negligently failed to implement adequate safety measures and supervise its software developers, leading to theft of the plaintiffs’ assets.

 

A federal judge also recently greenlit the first-ever criminal prosecution against an individual accused of transmitting more than $10 million worth of bitcoin to a virtual currency exchange located in a sanctioned country in violation of the International Emergency Economic Powers Act (IEEPA) and with the intent to defraud the United States.

 

Regulators are beginning to take action

The federal government is now seeking ways to gain control of this unsupervised market, with agencies like the Treasury Department, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) jockeying for position as lead regulator of digital assets. In another move toward government regulation, President Biden issued an executive order on March 9, 2022, establishing recognition of the unprecedented growth of cryptocurrency and the need to consider its regulation in light of potential risks associated with its growth. The order also directed the Treasury Department and Federal Reserve to continue exploring the adoption of a U.S. central bank digital currency. Internationally, the Basel Committee, a global standard setter for bank regulations, has suggested that it wants to limit digital asset exposure to a predetermined percentage of equity, including a risk premium for volatile assets.

 

As the federal government determines the best way to regulate digital assets, banks should review their current insurance policy to ensure they have the right coverage. For a more in-depth look at these issues, please download this guide. You can also contact your local insurance agent or broker for more information.

 

Article contributors:

Elizabeth Maio, AVP, Financial Institutions and Industry Leader

Matt Mulqueen, Shareholder, Baker Donelson, Bearman,

Caldwell & Berkowitz, PC

Pete Brunson, Associate, Baker Donelson, Bearman,

Caldwell & Berkowitz, PC

Veronica Odierno, AVP. National E/O FI Product Leader

Jocelin Singer, Risk Control Consultant

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One or more of the CNA companies provide the products and/or services described. The information is intended to present a general overview for illustrative purposes only. Read CNA’s General Disclaimer.
One or more of the CNA companies provide the products and/or services described. The information is intended to present a general overview for illustrative purposes only. Read CNA’s General Disclaimer.
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