“Fasten your seat belt. It is going to be a bumpy night” Bette Davis in “All About Eve”

I am sure one wandering trader said to another in history: can you ever imagine exchanging our goods for anything but frankincense and myrrh? We live in the circumstances that we know. Right now, those circumstances are rapidly changing. And, when anything rapidly changes, there is going to be a bumpy ride.

Indeed, the last 90 days have been bumpy for many things crypto, blockchain, stablecoin and NFT (see the definitions below). Many of the major crypto currencies have lost significant value. In fact, billions of dollars have been lost on paper. Of course, billions of those dollars had been gained only on paper. Put it in context, and it is really just par for the course for the nascent world of digital currency.

Source: https://markets.bitcoin.com/crypto/BTC as of 06/09/2021 at 12:30pm CDT

Is Cryptocurrency Currency?

To really understand where we are with cryptocurrency today, is to really understand the function that cryptocurrency serves in the markets. First and foremost, cryptocurrencies do not function as currency in the United States. In the United States, cryptocurrencies are simply speculative vehicles that are based on theoretical values. Why do I differentiate the United States from other countries? Well, because in some parts of the world cryptocurrencies are effectively serving as currency (Vietnam, Venezuela, El Salvador). Even more important than a cryptocurrency being stably pegged against a group of more stable currencies, is being able to utilize and monetize that currency in everyday society. I seem to personally offend Bitcoin Bros when I ask them if they can go buy a chicken in the corner store with their coin.

Even with the loss of billions on paper in cryptocurrencies, the epic failure that occurred from a stablecoin that broke the proverbial buck, and the collapse of Luna and various other crypto currencies and exchanges, I am a believer in digital currencies. In fact, I openly predict the demise of physical currency and the adoption and utilization of multiple digital currencies and blockchains in the U.S. economy in the next 10 years (maybe even less). 

Digital currency and blockchain is simply the technological evolution of a more efficient and secure system of exchanging goods and services. 

However, there is one important catch! In the United States, all digital currencies have to be regulated (A bill was introduced in the U.S. Senate by Senators Lummis and Gillibrand on June 7, 2022). If they are not regulated, they are doomed to failure-at least until we decide to change all of our banking laws to enable human traffickers, drug cartels, Russian Oligarchs, arms dealers, etc. to utilize our stable financial system. (Raise your hand if you are in favor of that. Ok, you are in favor. Now go find 218 members of Congress and 60 U.S. Senators to also agree. It is kind of chilling when I put it that way, isn’t it, bro?)

Despite the obscurity in the name cryptocurrency, much of the coming regulation will be focused around transparency in digital currencies. And banking regulators will be focused on their member institutions risk management and compliance control practices as those institutions intersect with cryptocurrencies, stablecoins, NFTs or, overall Blockchain technologies.  The regulation will come from law enforcement, the U.S. Treasury, and the banking regulators. Law enforcement will be particularly focused on tracking down financial crimes and preventing the use of the system by criminals. The Treasury will be focused on preventing financial crimes and systemic risk to the U.S. economy. And, banking regulators will be concerned with member financial institutions maintain proper risk and compliance controls in their inevitable intersection with cryptocurrencies. And, regulated financial institutions (including the Federal Reserve) and their regulators need to be concerned with how to stay relevant in the inevitable and approaching world that is dominated by blockchain and digital currency. 

DEFINITIONS

Blockchain: Is a digitally, distributed ledger than is immutable by any single party to the ledger. Al cryptocurrencies are based on blockchains. Information comes into the ledger in blocks and is digitally chained to the other blocks. No single user, but instead all collective users, maintain control of the chain. Thus, the description as Trustless)

Cryptocurrency: is an encrypted chain of data that is monitored and organized by a blockchain as described above. A common misnomer is that a cryptocurrency needs to disguise the transactions and parties along the particular chain. However, cryptocurrencies have been used as currencies by people conducting illegal activities.

Stablecoin: is a fixed price cryptocurrency whose market value is attached to a stable asset. Much like a money market fund, a stablecoin should not break the buck; meaning fall below the inherent value of the stable asset it is tied to. (Terra Coins recently collapsed when it was tethered to another cryptocoin, Luna, and Luna went bankrupt. This creates the question about the real definition of a stablecoin.)

NFT: a non-fungible token, is a financial security consisting of digital data stored in a blockchain. NFT’s have been used for a wide variety of purposes including purchasing portions of fine art, music, copyrighted material etc.. The stability of the value of an NFT is open to a wide degree of speculation. The long-term value and market for NFT’s is open to debate.

Click to learn more about the proven HDCompliance higher-risk compliance banking solution. 

Andy Montgomery

Founder & CEO | HDCS 

“Every informed person needs to know about Bitcoin because it might be one of the world’s most important developments”. ~  Leon Louw, Nobel Peace Prize Nominee 

Why are we seeing this acceleration in blockchain? There are a multitude of reasons, but I will boil it down to the following few: 

1. Demographic Acceptance: I tell bankers all the time to talk to their under 40-year-old clients. Hint: they aren’t in your lobby. Ask them if they hold crypto. Ask them if they can conceive of a way of interacting business on a blockchain. Then ask them if you can Venmo them $20 for their time.
2. Global crisis: Covid accelerated all things virtual: meetings, commerce, social interaction, eating (well ordering food). Cash is also inherently dirty as it changes hands and is a great way to spread germs. Add to that, it is a way to conduct commerce in regions in which the financial system is impaired (i.e. Ukraine and Russia).
3. Politics: The far right and the far left both mistrust the centralized banking system and the power of the money center banks. Situations like when Canada blocks the bank accounts of protesting truckers adds fuel to the fire. Gens Y and Z saw their parents and families struggle through a massive financial crisis, which was caused by excessive risk taking from large institutions, which the government bailed out. Putting aside crypto or transparent blockchain, there are large segments of the U.S. population that are looking for an alternative to financially interact.

So, what does that mean for the U.S. Banking system?  

Well, it is not going away any time soon. In fact, inevitably we are going to see greater regulation in the U.S. surrounding cryptocurrency. The immediate challenge for the banking system will be how to embrace, if not drive, blockchain initiatives while complying with U.S. banking regulation and laws-both those that exist now and those that will be written in the coming months. Clearly, a completely cryptic blockchain can’t be integrated into the banking system or broadly into the money supply as it violates Anti-Money Laundering and Bank Secrecy Act regulations.  

We believe there will be a balance struck that requires institutions to understand the direct source of funds on the chain before those funds can be domesticated into the system. More importantly, institutions that drive their own chain or tokens will have a decided advantage over the next decade as we experience a wholesale economic and political transfer of power to Generations Y and Z. 

“Whereas most technologies tend to automate workers on the periphery doing menial tasks, blockchains automate away the center. Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customer directly”. ~ Vitalik Buterin, Co-Founder of Ethereum 

If you would like to learn more about HDCompliance’s proven higher-risk compliance solutions, visit our website or contact Andy directly at a.montgomery@hdcompliance.com. 

Andy Montgomery  

Founder & CEO  |  HDCS, Inc.

If you have ever attended one of our webinars (or speaking engagements) you will hear us say, “If your institution is in a state, or borders a state, that has some form of legalized cannabis sales, odds are that cannabis-related cash is in your financial system.” This has been an educated guess…until recently.

Here is a well-known fact: In 2021, legalized cannabis sales in the US grew 40% to $25B and a substantial amount is going through the US banking system, unreported or undetected.

Recently, researchers from four (4) different universities put together an abstract titled, “THC and the FDIC: Implications of Cannabis Legalization for the Banking System” dated December, 2021.

Below are some pertinent facts from the research:

• It examines the effect of state-level adult-use legalization on banks’^[1] deposit and lending activity.
• While the legal implications of accepting deposits from cannabis-related businesses are uncertain, the question of whether these funds make their way into the banking system is an empirical question.
• It found evidence that banks located in legalizing states exhibited higher levels of deposits after legalization relative to banks in the same period in non-legalizing states.
• It also found that lending activity increased for banks in legalizing states, and while increases in lending were less sensitive to deposits compared to non-legalizing states, this difference was economically small.
• Although banks can choose either a state or federal charter, all banks are subject to several federal regulations, which may make banks hesitant to engage in relationships with cannabis businesses.
• Although there is some guidance, the guidance we have is vague with respect to cost of compliance and threat of prosecution over time as national political attitudes change, so banks may remain reluctant to provide services to cannabis-related businesses.

The research concluded that there were two mechanisms by which banks may accept deposits from cannabis-related businesses:

1. Banks may believe that the federal government will keep its promise not to prosecute banks that conduct higher-risk customer due diligence. And if banks have these risk-based compliance measures in place and have the proper cost structure in place to allow the benefits to exceed the risks, the bank may accept deposits from cannabis-related businesses.
2. Cannabis-related depositors may operate discretely and not identify themselves, and the bank simultaneously opts to avoid investigating further (don’t ask, don’t tell).

Even though these research above demonstrates that cannabis-related cash is flowing through our financial system, there still is a banking shortage, including lending opportunities.  Most recently, a Whitney Economic report concluded that over 70% of the cannabis industry’s biggest concern is the lack of banking.

And furthermore, if you are a cannabis-related business, it is not a good practice to conceal your involvement in the cannabis industry as that is, by definition, money-laundering and you and your beneficial owners could face serious fines and potentially jail time as demonstrated in this legal case in Oklahoma.

HDCS works with several community banks and credit unions throughout the US assisting in the implementation of a risk-based cannabis banking and lending programs. After implementation we also assist with the ongoing monitoring and reporting along with keeping our financial institution clients up to date on all local and federal regulation and legislation.

To learn more about the HDCS proven solution, visit our website or email me directly at b.postar@hdcompliance.com.

Becky Postar

COO  |  HDCS, Inc.

Last fall J.P. Morgan Chase made a strategic decision to no longer facilitate trades of cannabis stocks for its customers. At almost the same time, Bank of America exited as a client a DEA -approved scientific laboratory that was studying the effects of cannabis. Why? Is it because the large money center banks have a cultural issue with cannabis? Considering that more than 70% of Americans support legalized adult sale and use of cannabis, it is difficult to believe that they are worried about customer backlash.

The truth is that the cannabis market is just not big enough yet for them to be concerned about. Am I really saying that a $25 billion market is not big enough for them to be concerned about? Yes! That is exactly what I am saying.

The largest banks in the United States are so massive that they have little interest in taking on the regulatory complexities that come along with cannabis. There is just not enough profit in the business to have to solve it. And, if they get it wrong (i.e., fail to put appropriate AML/BSA procedures and train staff throughout their massive retail complex), the consequences could be significant. I will leave aside that I know for a fact through my interactions with the industry that the money center banks already have a massive amount of legal and illegal cannabis funds flowing through their retail networks. Instead, I will maintain that they will not openly embrace cannabis clients unless they look like and generate the profit like larger corporations that are the bread and butter of the money center banks.

So, the same must be said of crypto right? Not exactly! The money center banks have been able to spurn crypto in the past for the same reasons they spurn cannabis. But crypto represents a real disruption to the entrenched banking system. We are entering a world of blockchain, defi, digital currency, NFT’s and stable coins that is accelerating at a very rapid pace. If the money center banks don’t adapt quickly, they face a considerable attrition in their business models. Don’t believe me? Consider where J.P. Morgan is spending their money and this recent quote from its CEO Jamie Dimon: “the bank needs to pay top dollar for talent and make other investments to beat back the threats from both traditional financial institutions and upstart fintechs. It’s a lot of competition, and we intend to win. And sometimes that means you’ve got to spend a few bucks.” American Banker, January 14, 2022.

For more insight on big banks and cannabis banking, listen to our COO’s interview on the Investor Ideas Podcast.  

To learn more about how HDCS assists community banks and credit unions on how to safely bank the cannabis industry visit our website at hdcompliance.com or contact me directly at a.montgomery@hdcompliance.com.

Andy Montgomery

Founder & CEO  |  HDCS, Inc.