Digital payments technology is forcing the financial system to evolve. Banks feel their power waning and want to regain control.
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In 2014, as regulators in New York were exploring ways to control Bitcoin, executives at Wall Street’s biggest banks fretted that regulating cryptocurrencies would also legitimize them — and that could threaten the finance industry. So they tried to sow doubt.
At the World Economic Forum in Davos that year, Jamie Dimon, the chief executive of JPMorgan Chase, the nation’s largest bank, called Bitcoin a “terrible” store of value that was also being used for illicit purposes. At a meeting to discuss violations of Iran sanctions, H. Rodgin Cohen, the finance industry’s pre-eminent lawyer, warned the state’s regulators that the federal government was “very worried” about Bitcoin and its use.
Those efforts failed. New York’s Department of Financial Services began issuing licenses for Bitcoin businesses in 2015. There are now more than 75 million users of Bitcoin, up from around three million seven years ago, and the number of digital currencies has exploded. Globally, 220 million people use cryptocurrencies, according to a July report by Crypto.com.
“Most people agree that in the future — it might be 10 or 20 or years or it might be sooner — effectively all assets are going to be in a digital format,” said Thomas Olsen, a partner at Bain & Company who advises financial firms on cryptocurrencies and other digital asset matters.
Now the banking industry is racing to catch up. Banks want to compete in this new world and profit from it. Their approach is two-pronged: experimenting with cryptocurrency offerings and lobbying regulators to create rules that work in the banks’ favor. Some are offering cryptocurrency investments to their wealthy clients. Others are weighing trading desks for Bitcoin. JPMorgan even started its own digital currency in 2019.
And instead of warning regulators away from cryptocurrencies, banking industry representatives now complain that regulators have not acted quickly enough and that their inaction is costing banks valuable time in their mission to compete.
But their initial skepticism has cost them time. An alternative financial world is springing up around the traditional banking industry. Cryptocurrency start-ups are beginning to offer credit cards and loans. People and businesses around the world are embracing digital currencies at a rapid pace. Even governments are getting involved. El Salvador recently said it would accept Bitcoin as legal tender. And the Federal Reserve, following in the footsteps of central banks around the world, is evaluating launching its own digital currency.
The traditional banking system held sway for centuries. Banks have long helped governments control the flow of money in their local economies by taking deposits, then lending some of that money to other customers. With the rise of secondary markets for loans, banks could lend even more against the deposits they had by selling the loans to investors after they were made and freeing space on their balance sheets to do more lending. At every step of the way, they made money.
When Congress relaxed regulations in 1999 to let commercial banks enter the fray on Wall Street, their power increased again. They could now make markets in almost anything, like oil, wheat or government bonds, aiding sales and purchases of all kinds even as they helped everyday Americans make and receive payments, buy houses and start businesses.
Digital currencies, which let individuals bypass banks in money transfers, sales and business collections by connecting people instantly without an intermediary, are threatening to take away that central role banks play.
Outwardly, top executives at the biggest U.S. banks have shown little enthusiasm for digital currencies. Mr. Dimon continued to be skeptical, calling Bitcoin a “fraud” in 2017. More recently, he declared it “worthless.” And three years ago, Bank of America’s chief executive, Brian Moynihan, barred the giant company’s wealth managers from putting any client money into cryptocurrency-related investments.
But some individual bankers were getting curious. After spending years privately ridiculing Bitcoin, Thomas Montag, Bank of America’s chief operating officer, asked a friend of his for a tutorial on cryptocurrencies and spent hours listening to lectures, reading books and meeting with executives from cryptocurrency businesses, according to a person familiar with the discussions who spoke on the condition of anonymity.
Last year, engineers at Bank of America filed the biggest number of patent applications in the bank’s history, including hundreds involving digital payments technologies. It’s unclear how exactly the bank plans to use its technology, but it was partly driven by the desire to keep customers within the bank’s systems rather than lose them to scrappy cryptocurrency start-ups that allow them to transfer money free.
“The bank sees potential in blockchain, and we’re currently a leading patentholder in the space with more than 160 patents,” a Bank of America spokesman, Mark Pipitone, said. “But we still haven’t found a use at scale to make the financial lives of customers and clients better.”
Other big banks are embracing more direct contact with cryptocurrencies. Bank of New York Mellon and Northern Trust are working on offering custodial services to their clients — essentially bank accounts for other banks — that would hold Bitcoin. On Oct. 5, U.S. Bank announced that it would offer cryptocurrency custody services to money managers.
Just as it does for stock and bond prices, Goldman recently began posting digital asset prices on its Marquee platform for big clients like hedge funds, preparing for a time when the bank might be able to support trading in cryptocurrencies.
In 2019, a unit of JPMorgan called Onyx introduced JPM Coin, a digital currency backed by the dollar that ran on Quorum, an internal technology that mimicked the structure of blockchain. But the bank controlled Quorum, unlike Bitcoin’s blockchain, which is decentralized. It recently spun off Quorum to a software start-up.
JPMorgan also started an all-digital system that mimics the traditional “overnight repo” market, where banks exchange short-term U.S. government debt securities for cash. These transactions used to take more than a day to complete — hence the “overnight” label — but JPMorgan’s platform does them in just 15 minutes, reducing risk. It has only three users so far, and two are JPMorgan’s own businesses. Goldman this year became its first outside participant. If more banks join, JPMorgan could end up controlling one of the most crucial short-term funding markets in the world.
Igor Pejic, an expert on cryptocurrencies, said JPMorgan was one of a few major banks whose experimentation with blockchain — the technology underlying digital currency transactions — has made them digital pioneers poised to profit in the future from systems they’re testing now because, he said, “they are setting up an infrastructure which at the end of the day they control.”
But soon after JPM Coin went live, regulators began calling, said a person familiar with the matter who was not authorized to speak publicly. They worried that the movement of the coins around the financial system could cause a buildup of risk because they were tied to the dollar, sparking a panic and leading to the 21st century version of a bank run. The bank had to cut back on the scope of JPM Coin’s use.
Now, JPM Coin cannot be used to transfer value outside JPMorgan’s internal systems. Bank customers can use it to move dollars and other assets back and forth inside the bank almost instantly, but it is meaningless in the wider world.
Regulators have also trained their sights on smaller banks trying to build cryptocurrency businesses. In 2018, the New York-based Quontic Bank, with just $1 billion in assets, asked the top U.S. banking regulator, the Office of the Comptroller of the Currency, for feedback on its plans to launch a debit card program that gave customers rewards denominated in Bitcoin.
Quontic’s chief executive, Steven Schnall, wanted to be able to offer his customers rewards that might increase in value as Bitcoin did.
Mr. Schnall said he was surprised by the intensity of the questioning he and other top executives received from regulators. The O.C.C. lawyers envisioned an almost endless list of problems. What if Quontic customers lost their Bitcoins? What if the bank account holding them was owned by a trust and not an individual person? How would they be divided if someone died? The deliberations took two years, and at the end there was no clear green light.
“They just forced us through a process to make sure that they had clearly identified all of the risks,” Mr. Schnall said. Quontic decided to go ahead with the program. It chose to rely on an outside firm to handle everything related to Bitcoin so that Quontic would not actually have to “touch” the cryptocurrency.
Regulators, who were caught off-guard by the rapid adoption of cryptocurrencies, are scrambling to write new rules governing their use. And banks see a fresh opportunity to lobby regulators on writing rules in a way that benefits them.
Bank lobbyists are pushing regulators hard for uniform rules around cryptocurrency-focused lenders and other companies that transfer money and offer services similar to banking, arguing that unless they are subjected to the same controls banks face, the newer businesses will enjoy an unfair advantage.
American banks are also taking a stand against the Federal Reserve’s exploration of its own digital currency. The American Bankers Association, which represents the largest U.S. banks, warned members of the House Financial Services Committee this past summer that the negative consequences of creating a central bank digital currency “could be severe.” The association said there did not seem to be a pressing need for one because “the dollar is largely digital today.”
Mr. Cohen, senior chairman of law firm Sullivan & Cromwell, who years earlier warned New York regulators off Bitcoin, is among those pushing for greater regulation.
“We need a regulatory approach to cryptocurrency,” Mr. Cohen said in an interview with Bloomberg Television last month. Creating new rules would be “very difficult,” he said, “but that really should be a prod rather than an excuse.”
Lananh Nguyen and Kate Kelly contributed reporting.