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Introduction
If policymakers fail to move decisively, the United States risks stifling a transformative industry or witnessing a financial collapse reminiscent of the 2008 banking crisis.
The rapid rise of crypto banking presents both an unprecedented opportunity and a looming financial catastrophe. The federal government must act swiftly to implement a balanced regulatory framework that averts an impending crypto crisis while preserving the innovation that blockchain technology offers.
Integrating digital assets into the financial system has created a volatile yet revolutionary sector: crypto banking. While proponents argue that blockchain technology offers unparalleled efficiency, financial inclusion, and decentralized control, skeptics—including regulatory agencies—warn of systemic risks, fraud, and liquidity crises.
The collapse of FTX in 2022 demonstrated how unregulated financial structures can implode overnight, leaving customers without recourse. At the same time, institutions like J.P. Morgan have maneuvered into the space, potentially monopolizing digital finance with the backing of federal regulators.
The federal government must craft an urgent yet balanced approach to prevent a crisis while ensuring that crypto banking’s transformative potential is not suffocated under bureaucratic weight.
Institutional Monopoly and the Centralization of Crypto Banking
A core concern among crypto enthusiasts, including Custodia Bank founder Caitlin Long, is that the federal government’s regulatory stance creates an institutional monopoly in digital finance. By systematically rejecting crypto-native banking institutions while allowing legacy banks like J.P. Morgan to build their blockchain infrastructure, regulators may be consolidating power within the traditional banking system.
Long has argued that the Federal Reserve’s rejection of Custodia’s application for a banking charter in 2022—while allowing JPMorgan to develop a private Ethereum-based blockchain—reflects a deliberate strategy to consolidate power among legacy banks (Long, 2022).
This selective gatekeeping raises critical concerns: Is the government genuinely concerned about consumer protection, or is it ensuring that only established financial institutions benefit from digital asset integration? Long asserts the Fed’s attitude toward banking and creating monopolies, stating in an interview at ETHDenver, “If we (The Fed) like you, you get in. If we don’t, you don’t.” (2025).
The de-banking of institutions like Custodia suggests that regulators are not seeking to eliminate crypto banking but to control its onramps and restrict its adoption outside traditional financial structures.
Debunking DeFi Theory: Crypto is Tied to Traditional Markets
A standard narrative among cryptocurrency advocates is that DeFi (Decentralized Finance) operates independently of traditional financial systems. However, as previously discussed in my article, “Current Challenges: Debunking DeFi Theory and Evaluating The CRE Generational Divide,” crypto markets are deeply interconnected with macroeconomic conditions.
The claim that DeFi exists in a financial vacuum has been disproven multiple times, particularly during economic downturns. The 2022 FTX collapse, the UST de-pegging, and the 2023 SVB (Silicon Valley Bank) collapse demonstrate how liquidity shocks in traditional finance can lead to cascading failures in the crypto sector.
This correlation became even more evident in 2020, when Bitcoin’s surge was not a product of organic growth but a direct consequence of the Federal Reserve’s Quantitative Easing (QE-4). As liquidity flooded traditional markets, Bitcoin and other digital assets benefited, revealing their dependence on conventional financial conditions rather than complete independence.
Is the Federal Reserve Trying to Prevent a Repeat of 2008?
If regulators delay clear crypto banking policies, the industry risks repeating the mistakes that led to the 2008 subprime mortgage crisis. However, an alternative argument suggests that the Federal Reserve’s aggressive stance on crypto banking is not just about consolidating power—it may be a preemptive measure to prevent another financial meltdown.
Excessive risk-taking, opaque financial products, and a lack of oversight fueled the 2008 Great Recession. Financial institutions engaged in reckless mortgage lending, bundled high-risk loans into securities, and offloaded them onto the market without proper safeguards. Systemic collapse ensued when the housing bubble burst (Federal Reserve Board Report, 2009).
Crypto banking, if left unchecked, could follow a similar trajectory. Without regulatory safeguards, the following scenarios could unfold:
- Uncontrolled Leverage: Crypto banks and DeFi platforms could overextend loans using volatile assets as collateral, leading to cascading liquidations in a market downturn.
- Opaque Risk Exposure: Many crypto institutions operate without clear transparency on reserves, leading to uncertainty about solvency—a phenomenon seen in the collapse of TerraUSD and FTX.
- Systemic Contagion: As seen with Silvergate and Signature Bank, traditional banks exposed to crypto can face sudden liquidity crises, creating ripple effects across the financial system.
From this perspective, the Federal Reserve’s cautious approach may not be about monopolization alone but rather about risk mitigation. Given the systemic risks posed by an unregulated crypto industry, the Fed may be trying to prevent another financial disaster rather than allowing the industry to grow unfettered into another 2008-scale crisis.
Visualizing the Correlation Between Financial Crises and Crypto Markets
Bitcoin’s price movements during major economic events are a key indicator of how financial crises affect the crypto industry. The S&P Global (2023) graph illustrates a direct correlation between Bitcoin’s annual returns and Federal Reserve monetary policies.
- Bitcoin’s Rally in 2020: The surge in Bitcoin’s price coincided with the Federal Reserve’s Quantitative Easing (QE-4) program during COVID-19. The Fed injected liquidity into the economy, driving institutional interest in crypto.
- Market Crashes and Contagion Effects: Markers such as the UST, FTX, and SVB collapses correspond with Bitcoin’s sharp declines, showing how financial instability directly affects the crypto market.
- Quantitative Tightening (QT-1, QT-2): As the Fed reversed its expansionary policies and entered a tightening phase, Bitcoin suffered heavy losses, illustrating its reliance on liquidity-driven market conditions.
This visual representation underscores a critical reality: crypto markets are not isolated from traditional financial systems but are deeply interconnected with macroeconomic policies and crises. Without regulatory oversight, crypto banking could amplify financial instability rather than mitigate it.
A Path Forward: Urgent but Balanced Regulation
The federal government must enact regulatory policies that achieve two core objectives: mitigating systemic risks while fostering innovation. The solution lies in:
- Defining Clear Stablecoin Regulations: Stablecoins form the backbone of crypto banking, yet their reserves and risk models remain ambiguous. A federal framework ensuring transparency and liquidity requirements must be implemented swiftly.
- Allowing Narrow Banking Models: Instead of shutting down institutions like Custodia, regulators should permit 100% reserve crypto banks to operate under strict risk parameters. These banks offer a safer alternative to highly leveraged DeFi lending.
- Developing a Federal Crypto Banking Charter: Institutions are left operating in regulatory limbo without an official pathway for crypto banks. A formalized charter would provide a legal framework while preventing the consolidation of power in traditional banks.
- Establishing a Digital Asset Liquidity Backstop: In a market crisis, a structured backstop—similar to the Federal Reserve’s role in traditional finance—could prevent mass insolvencies.
Conclusion
Crypto banking represents a financial revolution that cannot be ignored. However, without swift federal action, traditional banks could either monopolize the industry or collapse under the weight of their risks.
The government stands at a crossroads: embrace innovation while mitigating risks, or allow history to repeat itself with devastating consequences.
As crypto banking continues to evolve, policymakers must balance regulation with progress, ensuring the financial system remains stable while fostering the next generation of financial technology.
Comment your thoughts on where you see the industry headed! Is the Fed hoping to avert a financial crisis or create an institutional monopoly?
Stay tuned for more developments (exclusive insights, podcast interviews, and events).
References
- Federal Reserve Report (2009). “Cause of the 2008 Financial Crisis and Policy Responses.”
- Long, C. (2022). “The War in Crypto Banks: How the Fed is Picking Winners and Losers.”
- U.S Senate Banking Committee (2023). “Stablecoin Legislation and Banking Policy Reform.”
- Federal Deposit Insurance Corporation (FDIC) Report (2023). “Banking Innovation and Risk Assessment in Digital Finance.”
- S&P Global (2023). “Are crypto markets correlated with macroeconomic factors?”
