The political earthquake that just shook Washington is about to impact Bitcoin banking regulators – from the SEC to the CFTC, IRS, OCC and beyond – in a transformational way. Specifically, the SEC’s crippling SAB 121 guidance is widely expected to be overturned. What does this mean for banks and the customers they serve?
A Brief History of SAB 121
Let's take a brief look at the history of SAB 121, why banks generally dislike it, and how lawmakers have recently addressed it in congress.
Why the SEC created it
Staff Accounting Bulletin No. 121 (SAB 121) was introduced by the U.S. Securities and Exchange Commission (SEC) in March 2022. The SEC created SAB 121 to address the unique risks associated with crypto-assets held by entities for their customers, particularly focusing on the technological, legal, and regulatory uncertainties these assets present. SAB 121 mandates that companies must reflect the crypto-assets they hold for clients as both an asset and a liability on their balance sheets, alongside providing detailed disclosures about these risks. This was intended to enhance transparency and protect investors by ensuring that the financial statements of these entities reflect the potential liabilities and risks of crypto-asset custody.
Why banks dislike SAB 121
Banks and other financial institutions have been primarily critical of SAB 121 because it significantly increases their capital requirements. But the critiques of SAB 121 are legion:
- The rule reads strongly as if it’s enforceable in court
- Banks are forced to hold significant additional capitol against Bitcoin holdings, making it prohibitively expensive to offer Bitcoin custody services at scale
- It may conflict with OCC guidance (The OCC's Interpretive Letter #1170 (2020) allows national banks to provide custody services for crypto-assets under certain conditions, focusing on risk management rather than specific accounting practices)
- Consumers are denied the use of traditional banking custodians they may trust the most (vs. newer digital asset custodians such as Coinbase)
- Consumers are denied protection of their assets during bankruptcy claims (due to the “on-balance sheet” treatment of Bitcoin which would be subject to creditor claims, instead of remaining property of the customer)
- Custody of Bitcoin and digital assets is overly concentrated with Coinbase, increasing systemic risk (risks associated with single points of failure - operational errors, market manipulation, and more - increase without a diversification of custodians)
- Staff Accounting Bulletins – and thus SAB 121 – are regularly created without consulting affected parties (Hester Peirce, 2022)
The bipartisan backlash against SAB 121
The backlash against SAB 121 led to a significant legislative response. In 2024, both the U.S. House of Representatives and the Senate passed a resolution under the Congressional Review Act (CRA) to overturn SAB 121, marking a rare bipartisan effort in Congress. This resolution was supported by those arguing that the SEC overstepped its bounds by issuing SAB 121 without proper regulatory process or oversight.
However, President Joe Biden vetoed this resolution, expressing concerns that overturning SAB 121 would limit the SEC's ability to manage future regulatory challenges. An attempt to override the veto in Congress failed to garner the necessary two-thirds majority, thus maintaining SAB 121 in place, although discussions and legal challenges regarding its implications continue.
The Future of SAB 121
So, what will happen to SAB 121 given the congress' prior vote to overturn SAB 121?
SAB 121 is doomed
The future of SAB 121 is precarious with Donald Trump's presidency and a Republican-led Congress in 2024. Trump has openly expressed pro-Bitcoin sentiments, promising to foster a more favorable environment for Bitcoin adoption in the U.S., which directly contradicts the stringent measures of SAB 121.
With the incoming administration's stance, coupled with both Republican and some Democratic support in Congress, there's a strong indication that renewed efforts will be made to nullify or significantly alter SAB 121. This could be part of a broader strategy to "defeat the anti-crypto army," referring to those regulatory and political forces against Bitcoin’s growth and integration into traditional finance, thereby potentially sealing SAB 121's fate.
What might replace it?
In place of SAB 121, we might see new regulatory guidance that focuses on transparent accounting practices while ensuring the safe custody of digital assets. This new framework could allow Bitcoin and other cryptocurrencies to be held off-balance sheet, providing a safeguard for consumers' assets in the event of a custodian's bankruptcy, leveraging the expertise of the nation's most trusted custodians.
New Bitcoin services that banks may begin to offer
With these coming regulatory shifts on the horizon, particularly concerning SAB 121, banks are poised to expand their involvement in the Bitcoin and cryptocurrency space. Some, like BNY Mellon, are already moving forward with their new digital asset custody platforms. This evolution could lead to an array of new Bitcoin services being offered by traditional financial institutions.
The following is an overview of these new services, from trading and custody to lending and innovative payment solutions, illustrating how banks might integrate Bitcoin into their offerings to meet both consumer demand and regulatory compliance.
Trading Services
Spot Trading: Banks might offer direct buying and selling of Bitcoin for their clients, similar to how they handle stocks or bonds. This would allow clients to trade Bitcoin through their existing banking platforms.
Futures and Options: Offering Bitcoin derivatives could be next, allowing clients to hedge or speculate on Bitcoin's price without owning the actual cryptocurrency. This could include Bitcoin futures contracts, options, and possibly even more complex financial instruments.
Custody Services
Secure Storage: Beyond just custody, banks beyond BNY Mellon and others will offer high-security cold storage solutions for Bitcoin, ensuring that client assets are protected against hacks and cyber threats.
Institutional Services: Tailored custody solutions for other financial institutions, corporations, or high-net-worth individuals who need secure, regulated Bitcoin storage.
Lending Services
Lending Against Bitcoin: Banks will start lending services where Bitcoin is used as collateral (Cantor Fitzgerald has already moved forward with their new lending offering, using Bitcoin as collateral for loans). This would involve creating frameworks for valuing Bitcoin as collateral, similar to how they handle other assets like real estate or securities.
Investment Products
Bitcoin ETFs: If not already available, banks might facilitate easier access to Bitcoin ETFs for their clients, simplifying investment in Bitcoin through traditional investment vehicles.
Structured Products: Banks could create structured products around Bitcoin combining it with other financial assets to offer products with tailored risk-return profiles.
Payment Solutions
Bitcoin Payments: Banks could integrate Bitcoin into their payment systems, allowing merchants and consumers to use Bitcoin and its high-speed, low-cost Lighting Network for transactions, possibly through debit cards or direct bank transfers.
Settlement Services: Offering faster, cheaper cross-border transactions using Bitcoin's blockchain and Lightning payments network could be appealing, particularly for international transfers.
Wealth Management and Advisory Services
Portfolio Inclusion: Financial advisors at banks - such as Morgan Stanley - are already including Bitcoin in portfolio recommendations, possibly as a hedge against inflation or currency devaluation.
Education and Consulting: Banks are already providing educational resources and consulting services to educate clients about Bitcoin's risks and benefits, compliance requirements, and how to integrate it into their financial planning.
Operational Use of Bitcoin
Internal Operations: Banks might use Bitcoin for their own operations, like settling transactions or managing treasury, to explore cost efficiencies and new operational models.
Blockchain Technology Adoption
Beyond Bitcoin: While focusing on Bitcoin, banks might also explore other blockchain technologies – such as the Liquid Network – for operational improvements or new financial products.
The Liquid Network offers faster transaction settlements with one-minute block times, enhancing efficiency in banking operations like inter-bank and cross-border transactions. The network's confidential transactions feature allows for increased privacy, vital for sensitive financial dealings.
Banks can also use Liquid for asset tokenization, issuing securities like stocks or bonds as tokens, and manage or issue stablecoins for more fluid digital currency transactions. Additionally, it supports lending against digital assets, offers potential for DeFi products, and could revolutionize cross-border payments with quicker, cheaper settlements. Compliance tools can also be integrated to meet regulatory requirements, allowing banks to expand into the Bitcoin space while maintaining trust and regulatory adherence.
Summary
We’re standing on the cusp of significant regulatory change with the anticipated end of SAB 121 under the new administration. The stage is set for revitalizing how banks interact with Bitcoin and digital assets. The elimination of SAB 121's draconian requirements will allow banks to integrate Bitcoin into their balance sheets without the prohibitive capital constraints, thereby opening the floodgates for a wave of innovation.
Banks will then be able to leverage advanced blockchain solutions like the Lightning and Liquid Networks to offer faster, more secure, and private transactions, reducing operational costs and enhancing customer services.
For consumers, this shift welcomes an era where trusted financial institutions can provide secure custody, trading, and lending services for Bitcoin, alongside potentially groundbreaking products like tokenized assets and stablecoins.
This not only democratizes access to digital finance but also mitigates risks associated with concentration in custody services, fostering a more resilient and diverse market. The end of SAB 121 may very well mark the beginning of a symbiotic relationship between traditional banking and the burgeoning world of Bitcoin banking, benefiting both banks and consumers by broadening financial inclusion and innovation.
