The crypto contagion may not be that contained

Thanksgiving is my favorite holiday, and there's not even a close second. Besides being held in late fall — the best season — and explicitly mandating everyone eat all the carbohydrates, Thanksgiving encourages people to glance up from their phones and take a moment to appreciate the precious things we already have. And then we look back at our phones again.

When I looked back at my phone, I found myself entranced with a story from The New York Times detailing how the busted crypto firm FTX had acquired a small stake in a tiny bank in Washington State for an exorbitant $11.5 million — the bank itself had about $21.7 million of assets as of the second quarter, and has had around $10 million of deposits for most of the last decade. 

That bank, once known as Farmington State Bank but now doing business as Moonstone Bank, was acquired in 2020 by a holding company led by Jean Chalopin — a name regulators may know as the owner of Deltec Bank, whose most significant client is the stablecoin issuer Tether. That might suggest to regulators that the acquisition was meant to facilitate crypto's entrée into the banking system in some way. 

Andrey Rudakov/Bloomberg

From there, Farmington — which at the time of its acquisition was not a member of the Federal Reserve System — applied to become a member, and was approved by the Federal Reserve Bank of San Francisco in June 2021. This in and of itself is not that big of a deal, because a nonmember bank can become a member bank fairly easily so long as it's still a bank and does bank things. But then in March of this year Alameda Research — the investment arm of FTX — bought just under a 10% stake in Moonstone, neé Farmington, for $11.5 million, which would value the bank at roughly $115 million. Ownership stakes below 10% do not require regulatory approval.

I'm not the first person to raise my eyebrows at that purported valuation, and I doubt I will be the last. But keep in mind that a Federal Reserve master account is a very valuable thing — so valuable, in fact, that many banks or banklike organizations dedicated to the proposition that crypto is the future have gone to extraordinary lengths to acquire one, and the Fed has likewise gone to extraordinary lengths to preserve its authority to keep them at arm's length. And it doesn't appear to be a secret that FTX's investment was meant to bring crypto into the banking system: In their March press release, Moonstone and its parent company said the bank's "transformation" was meant to turn it into a "top provider of innovative financial services to fast-growing industries such as blockchain, cryptocurrencies and cannabis." 

Why did FTX want a stake in Moonstone? Particularly one that coincidentally falls just below the threshold that would require regulatory approval? I don't know — I reached out to Moonstone and the Fed for comment, and the Fed declined. Moonstone, however, said in a press release Tuesday that it has "remained in close communication with our regulators" throughout its business evolution and has "built robust processes, programs, and controls to ensure all our activities comply with all applicable laws and regulations." The release goes on to say that Alameda has a noncontrolling stake, has no representation on the Moonstone board and has no impact on management, and added that "the unexpected collapse of [FTX] negatively impacted countless individual investors, investment firms, vendors, counterparties and unfairly affected Farmington State Bank d.b.a Moonstone Bank's reputation as well." Moonstone also noted that FTX's investment and the bank's valuation is "consistent with other similar technology Banks and Trust Banks [sic] startups at the time."

If this episode of the FTX saga means anything, it is that at least one crypto firm — that we know of — was sniffing around the perimeter of the banking system for some unknown reason. I want to be careful to point out that none of Alameda/FTX's moves here in and of themselves are necessarily wrong, and there is no evidence that Moonstone or anyone else did anything nefarious here. It's also worth noting that a bank with crypto clients isn't the same as a crypto bank. Nonetheless, Alameda/FTX saw some kind of benefit in having an ownership stake in this bank, and other crypto firms — think Voyager — have blurred the lines between bank and bank client before, at least in terms of presenting their deposits as insured when they are not.

What is important is this: If it was this easy for FTX to get its nose into the Fed's tent, how many more ever-so-slightly sophisticated camels have been doing the same thing, and how successful have they been? I don't know the answer to that question, and no one else does, either — that's part of the problem. But if Fed officials approved Farmington's sale and membership in the Fed system, they might have at least suspected that this bank could have been repurposed to create a crypto foothold in the banking system, something that the Fed says it wants to avoid.  

I'd like to take a beat to point out that I don't have anything against crypto as such — many people who are smarter than me are convinced that it will revolutionize money and finance as we know it. And it very well may — people thought the internet was a fad after the dot-com bust, after all. But I do have something against theft and fraud, and unfortunately we are in Day 3 of crypto's Woodstock '99, where the peace and love veneer has been torn off and the entire enterprise is revealed as a sinister, even premeditated con.

FTX gives Congress a reason to rein in crypto. The question is how.

Whenever something like this happens — be it a financial crisis or a failed music festival — it's easy to look around and identify the person or persons who should have known better and demand they account for how they could have been so blind. In the case of crypto, regulators have repeatedly assured the public that none of these failed firms crossed the financial blood-brain barrier. As a result, while the steep losses of ordinary investors' money are regrettable, there is little risk to the financial system as a whole. 

Clearly that is true in the aggregate — at least for now. That FTX had a lane to get into banking isn't the same as wrongdoing or malfeasance. If crypto had the capacity to tank the banking system that we all rely on, it would have done it by now. But if we are to be assured that the Fed is diligently keeping good guys in and bad guys out of the banking system, this kind of episode undermines that message — even if it is only in appearance rather than substance. The Fed has made some gestures about opening up its master account application process and guidelines, and that certainly would help. 

But what would help even more is a bright-line policy about where and how banking and crypto are supposed to interact. Banking is traditional, regulated and safe. Crypto is evolving, largely unregulated and involves a great deal of risk and reward. Different consumers might have very different preferences, and that's fine so long as your choice doesn't affect mine. If regulators want to keep these spheres separate, they should use their power to make it so, and if they think crypto can join mainstream finance, they should articulate exactly how that can be done safely.

Crypto has evolved quickly and regulation tends to move slowly — rather than moving fast and breaking things, regulators move carefully and try to keep things intact. Regulators have also been consistent in their public messaging that they view crypto with more than a little caution. Perhaps extending that consistency to include noncontrolling ownership stakes would clear up any confusion that the Moonstone/FTX news created — after all, consistent and fair regulatory oversight is something we can all be thankful for.