US Agencies Recommend Traditional Risk Management for Crypto Liquidity

US agencies recommend using old risk management principles

 for liquidating cryptocurrencies

The joint statement underscored the paramount liquidity risks associated with crypto-assets and their stakeholders for banking institutions. It highlighted the need for banks to be aware of the potential risks and to take appropriate measures to mitigate them.

In a joint statement released by three United States federal agencies, the banking sector was warned against creating new risk management principles to counter liquidity risks resulting from crypto-asset market vulnerabilities. 

The Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) issued a reminder to banks to apply existing risk management principles when addressing crypto-related liquidity risks.

The joint statement highlighted the key liquidity risks associated with crypto-assets and related participants for banking organizations, such as the unpredictable scale and timing of deposit inflows and outflows. In other words, the federal agencies raised concerns about a situation where a sudden surge in selloffs or purchases could negatively impact the liquidity of the asset, potentially leading to significant losses for investors.

The federal agencies highlighted two specific instances to illustrate the liquidity risks associated with cryptocurrencies: 

• Deposits placed by a crypto-asset-related entity for the benefit of their customers.

• Deposits that constitute stablecoin-related reserves. 

These examples demonstrate the potential for liquidity issues to arise in the crypto-asset space and underscore the need for investors to be aware of the risks associated with these assets.

In the first instance, the price stability of stablecoins depends on the behaviour of investors, which can be influenced by "stress, market volatility, and related vulnerabilities in the crypto-asset sector." The second type of risk is related to the demand for stablecoins. The joint statement read: 

"Such deposits can be susceptible to large and rapid outflows stemming from, for example, unexpected stablecoin redemptions or disruptions in crypto-asset markets." 

This highlights the importance of monitoring the crypto-asset sector to ensure the stability of stablecoins and protect investors from potential risks.

The trio of federal agencies - the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) - agreed that banking organizations are not prohibited from providing banking services related to cryptocurrency. 

However, they recommended that banks actively monitor the liquidity risks associated with crypto offerings and establish and maintain effective risk management and controls.

To ensure effective risk management, the agencies proposed four key practices for banks to follow. These include performing thorough due diligence and monitoring of crypto assets, incorporating liquidity risks into their assessment, understanding the interconnectedness between crypto offerings, and assessing the direct and indirect drivers of potential deposit behaviour.

On January 3, the same three agencies issued a joint statement outlining eight potential risks associated with cryptocurrencies, such as fraud, volatility, contagion, and other issues. They urged banks to be aware of these risks and take the necessary steps to mitigate them.

The agencies jointly stated:

“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system.”

The statement highlighted the possibility of changing crypto regulations with references to agencies’ “case-by-case approaches to date.”