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Fintech: OCC Issues Significant Ruling Permitting National Banks to Use INVN and Stablecoin Technology

The Situation: On January 4, 2021, the Office of the Comptroller of the Currency ("OCC") issued an Interpretive Letter permitting national banks and federal savings associations ("Banks") to participate in independent node verification networks ("INVN") and to use stablecoin, a type of cryptocurrency designed to have stable value, to conduct payment and other activities permitted for banks.

The Result: The OCC Interpretive Letter relies upon longstanding regulatory and case law precedent holding that the business of banking should evolve and adapt to technological changes as they occur. The OCC concludes that validating, sorting, and recording payment transactions by serving as a node on an INVN, issuing stablecoin, and exchanging stablecoin for fiat currency such as U.S. dollars are permissible bank-payment activities when conducted consistent with applicable law and sound banking practices.

Looking Ahead: The OCC Interpretive Letter is a significant step allowing for stablecoin and public blockchain integration into the traditional banking sector. By permitting Banks to participate in and use INVNs and stablecoins to carry out the business of banking, the OCC Interpretive Letter advances the potential for transfers of funds between financial institutions without the need for a government intermediary, increasing the speed and efficiency of domestic and cross-border payments. 

Recent Cryptocurrency Regulatory Decisions

Global market capitalization of digital assets continued to grow in 2020 following robust growth in 2019, though this growth has experienced some volatility. The 2020 Annual Report recently issued by the U.S. Financial Stability Oversight Council suggested that the "benefits and potential risks associated with digital assets underscore the importance of U.S. regulators adopting an approach to digital assets that will provide for responsible innovation in a manner that is safe, fair, and complies with all applicable laws" and further suggested that financial regulators should review existing and planned digital asset arrangements and their risks.

Additionally, in December 2020, the President's Working Group on Financial Markets issued a Statement on Key Regulatory and Supervisory Issues Relevant to Certain Stablecoins providing an initial assessment of key regulatory and supervisory considerations for participants in significant stablecoin arrangements with a U.S. nexus that are primarily used for retail payments.

Federal financial regulatory and intelligence agencies continue to take steps to improve clarity around the regulatory framework for digital assets. For example, the Securities and Exchange Commission ("SEC") and FINRA have issued Joint Guidance to broker-dealers holding that digital token custody and trading must fit within existing SEC and FINRA laws. The Financial Crimes Enforcement Network, Department of the Treasury ("FinCEN"), proposed a rule in December 2020 aimed at closing perceived anti-money laundering regulatory gaps for certain convertible virtual currency and digital asset transactions. The FinCEN proposed rule would require financial institutions "to submit reports, keep records, and verify the identity of customers in relation to transactions" related to virtual currency or digital assets held in digital wallets not hosted by a financial institution, known as "unhosted" wallets.

The Anti-Money Laundering Act of 2020 codified existing FinCEN guidance related to virtual currencies covering "value that substitutes for currency" to require virtual currency businesses that qualify as money transmitters to register with FinCEN, and establishes reporting and recordkeeping requirements for certain types of virtual currency transactions.

In September 2020, the EU released a Draft Statement discussing the regulation of markets in crypto-assets ("MiCA"). MiCA aims to set up a dedicated regulatory regime relating to crypto-assets offered to the public, together with a new regime applicable to service providers dealing in crypto-assets, while supporting financial innovation with pilot programs. The regulation on coin issuers and crypto-asset service providers would subject these entities to a single licensing regime across all member states without the need for "passporting." It creates an open framework allowing cross-European offerings, but also notes that crypto-asset servicers will be subject to licensing rules and ongoing regulatory requirements. These new rules would not prevent existing and regulated financial institutions from offering these services when applying for new licenses. It should be noted that asset-referenced tokens or electronic money tokens (i.e., stablecoin) would subject issuers to specific regulations, with particular attention paid to its customer base, number of transactions, size of the reserve used to back the tokens, among other criteria.

The OCC Interpretive Letter

The OCC has issued prior interpretive letters on permissible crypto-related activities by Banks, concluding, in an Interpretive Letter issued in July 2020, that Banks may provide cryptocurrency custody services, and that Banks may hold deposits that serve as reserves for stablecoin, in an Interpretive Letter issued in September 2020.

The OCC Interpretive Letter issued on January 4, 2021, further advances the OCC's regulatory analysis of digital assets clarifying that Banks may use INVN and stablecoin as permitted within the business of banking. The OCC has long held that payment activities are a part of the business of banking and consistent with a bank's primary function.

An INVN is a shared electronic database where copies of the same information are stored on a decentralized network of computers, such as a distributed ledger where cryptocurrency transactions are recorded. Stablecoin is a digital asset designed to maintain a stable value, usually relative to another asset, such as a unit of fiat currency or a commodity, or relative to a basket of assets.

INVNs provide a faster and more efficient process for validating and recording financial transactions. Acting as a node on an INVN to transmit payment instructions and validate payments essentially has the same result as the current methods by which a centralized entity is used to validate payments. The OCC sees the basic functions of INVNs as basic banking functions of transmitting payment instructions and validating payments, and accordingly concludes that a bank may act as a node on an INVN to enable payment activities.

The OCC recognizes that stablecoin is a legitimate method of payment, similar to debit cards, checks and electronically stored value ("ESV") systems. The OCC equates the use of stablecoins to ESV, each an electronic representation of the dollars on which they are based, and differentiates stablecoins from other popular cryptocurrencies that experience price volatility. According to the OCC, using INVNs and stablecoins may result in "a cheaper, faster, and more efficient means of effecting" payment, with a bank validating transactions on the INVN as a node, assisting in the conversion of stablecoins to dollars or issuing the stablecoin.

The OCC recognizes that there are both benefits and risks to INVNs and stablecoins and that while INVNs might provide stability and increase efficiencies in payment mechanisms, banks should be sure to use INVNs in a safe and sound manner. Similarly, the OCC notes that any payment activities that involve cryptocurrencies, such as stablecoins, may increase fraud, operational and compliance risks. For example, the OCC warns that cryptocurrencies might present risks associated with anti-money laundering and counter terrorism laws. Growing technologies often require additional expertise and innovative processes to manage these risks, and the OCC cites past developments in electronic custody services and data processing services as examples of proper industry and regulatory adaptations.

Four Key Takeaways

  1. The OCC's conclusion that it is legally permissible for banks to use INVNs and stablecoin technology in bank-permissible payment activities is a significant step in recognizing and integrating new technologies into traditional banking.
  2. Banks that want to participate in or use INVNs and stablecoin must possess the technological and other expertise to manage risks effectively. Banks should ensure they fully understand the associated fraud, money laundering, operational, technology, compliance, vendor, and other risks. Banks should revise their policies and procedures to address these risks.
  3. State-chartered banks should check their particular state's law regarding parity with national banks to understand how the OCC's Interpretive Letter may affect their legal authority to engage in INVN and stablecoin activities. 
  4. Clients need to understand the legal, regulatory, and strategic risks associated with INVNs and stablecoin, and should develop appropriate policies and procedures that satisfy supervisory requirements.

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