Risks and rating considerations related to entities operating within the global crypto ecosystem continue to evolve, including limited and varied regulatory frameworks, extreme crypto asset price volatility, growing legal complexities, counterparty risks, asset/liability concentrations and fraud, Fitch Ratings says.
 
The bankruptcies and crypto-related stress experienced over the past year have underscored some of the risks highlighted in our October, 2021 report Crypto Rating Considerations and Use Case Assessments, while other considerations such as counterparty concentrations, interconnectedness and treatment of custodied crypto assets in a bankruptcy, have come to the forefront. Qualitative factors such as risk management policies/controls and corporate governance efficacy are also highly relevant, but more difficult to externally assess or quantify.

 
Banks have mostly been insulated from the crypto fallout thus far, in part because of bank capital requirements and regulatory restrictions that have made it much less economically feasible to participate in the crypto ecosystem by investing, trading, lending or providing custody of crypto assets. The lack of comprehensive crypto regulation also serves to limit many of the channels through which crypto might otherwise permeate the broader financial system.
 
 That said, U.S. banks such as Silvergate Bank (not rated), and to a lesser extent Signature Bank (‘BBB+’/Negative), had deposit concentrations with crypto firms that used their networks to transact in cryptocurrencies. The banks experienced meaningful deposit outflows in 4Q22, prompting significant business disruptions, with Silvergate Bank realizing material losses when it liquidated a portion of its securities portfolio to meet deposit redemptions. While the speculative nature and high price volatility of crypto currencies exacerbated the situation, an accompanying risk aspect was customer/industry concentration, which is a fairly common risk and rating constraint for financial institutions.
 
 The lack of clear crypto regulatory standards across jurisdictions increases the risk of fraud and market manipulation amongst crypto players while limiting widespread institutional participation. On the other hand, the failures over the past few months could be a catalyst for legislative action that empowers regulators to create a more robust regulatory frameworks for crypto activities.
 
 More recently, the Securities and Exchange Commission has announced several enforcement actions against some of the larger crypto firms alleging violations of existing securities laws, while US bank regulators in January 2023 issued a joint statement indicating that they were closely monitoring banks’ exposure to crypto-related activities and highlighted the various risks. Although these actions do not go as far as the establishment of a formal regulatory framework for the industry, they nonetheless could be effective in reining in excessive risk taking within the crypto ecosystem.
 
 Looking forward, it remains important to distinguish between digital asset innovations in decentralized ledgers (often referred to as blockchain) and “smart contracts” offering greater potential economic utility versus highly speculative use cases for certain non-collateralized tokens. The tokenization of real tradable assets and decentralized ledgers have the potential to disrupt trading and investment strategies and existing money transfer/payment rails, whereas use cases for most privately issued crypto tokens are unclear. Similarly, while stable coins currently play a central role in decentralized finance as a store of value, their utility could be significantly diminished should central banks issue digital currencies or halt issuance of private stablecoins altogether- as the NY DFS did this week regarding Binance Holding LTD’s BUSD stablecoin.