OCC Permits National Banks and Federal Savings Associations to Use Independent Node Verification Networks and Stablecoins for Payment Activities

As part of the Office of the Comptroller of the Currency’s (OCC) declared effort[1] to keep pace with a mounting demand for faster, cheaper, and more efficient payments, and the widespread adoption of new technologies, the agency’s Senior Deputy Comptroller & Chief Counsel issued an interpretive letter on January 4, 2021 (the “Interpretive Letter”) clarifying the permissibility of independent node verification networks (INVNs) and related stablecoins. Under the Interpretive Letter, national banks and federal savings associations (FSAs) may use such new technologies to conduct bank-permissible functions, as long as such activities are conducted in a safe and sound manner and in accordance with applicable law.

The Interpretive Letter comes shortly after the release of a December 23, 2020 statement[2] from the President’s Working Group on Financial Markets (the “Working Group Statement”) on the regulatory and supervisory considerations for stablecoin arrangements. The Working Group Statement encourages responsible payments innovation, while highlighting the requirement to strictly comply with applicable law, including all relevant anti-money laundering (AML), countering the financing of terrorism (CFT), and economic sanctions obligations. The OCC shares the Working Group Statement’s emphasis on the importance of legal compliance in the development of INVN and stablecoin arrangements.

Definitions

INVN

• An INVN is a shared electronic database that stores multiple copies of the same information on different computers. The collective nature ensures accuracy, since information cannot be added until a consensus is reached that such information is valid. Furthermore, the consensus mechanism prevents tampering, as altering the data on one computer will not affect the data on other computers.
  
  • A distributed ledger is one form of INVN and is used to record cryptocurrency transactions. Some distributed ledgers are also known as “blockchains” because the stored transactions are grouped in blocks of data that are chained together. Nodes, or participants in an INVN, may validate transactions, record and store transaction data, and share data with other nodes.[3]

Stablecoin

• Stablecoin is a relatively stable kind of cryptocurrency, which may be backed by fiat currency or a basket of assets with a stable or pegged value. Typically, one unit of the fiat-backed stablecoin equals one unit of the underlying fiat currency. Stablecoins backed by other assets may be pegged to a fiat currency or managed by algorithm.[4]

The Progression

The Interpretive Letter follows a series of related developments from the OCC concerning new technologies. In October 2017, the OCC issued a bulletin (the “2017 Bulletin”)[5] advising on risk management associated with new activities for banks. The OCC recognized that banks have long adapted to new technologies and outlined how proper risk management, including due diligence, internal controls, change management processes, and monitoring could help banks remain both secure and competitive.

In an interpretive letter from July 2020 (IL 1170), the OCC concluded that banks and FSAs could provide certain cryptocurrency custody services on behalf of customers, such as holding associated cryptographic keys.[6] National banks have traditionally provided safekeeping and custody services for a variety of assets, and this well-established practice extends to cryptocurrency. The OCC noted that it already recognized and codified a national bank’s authority to escrow encryption keys in connection with digital certificates and to provide secure web-based document storage.[7] IL 1170 reaffirmed the OCC’s position that national banks may use new technologies to provide permissible banking services to any lawful business, as long as the bank effectively manages risks and complies with applicable law. In fact, the OCC and other federal banking agencies have encouraged banks to mitigate risks, rather than declining to provide banking services.[8]

In an interpretive letter from September 2020 (IL 1172), the OCC confirmed a national bank’s authority to hold an issuer’s stablecoin reserves as a service to bank customers, subject to specified conditions.[9] The permission was limited only to reserves for stablecoins that are associated with a hosted wallet,[10] backed by a single fiat currency, and redeemable on a 1:1 basis. The bank must verify, at least daily, that reserve account balances are equal to or greater than the issuer’s outstanding stablecoins. Ultimately, the OCC recognized that placing cash reserves for a stablecoin in a deposit account fell within the authority to receive deposits, a “core banking activity.” And as the OCC noted in IL 1170, banks may provide banking services, as long as such services operate in compliance with applicable law and risks are managed.

While past OCC guidance permits new technologies in general and certain cryptocurrency services, the Interpretive Letter is the first guidance from the OCC on the use of INVNs. Nevertheless, it follows the established precedent of permitting national banks to engage in payment-related activities within the business of banking.[11]

The Interpretive Letter

The Interpretive Letter clarifies the OCC’s position that national banks and FSAs[12] may serve as nodes on an INVN and use INVNs and related stablecoins to conduct permissible payment activities. These activities must be conducted in accordance with applicable law and safe and sound banking practices. OCC supervisors should be consulted prior to a bank’s engaging in these activities. As noted in the Working Group Statement, stablecoin arrangements must have the capability to identify and verify all transacting parties and have adequate systems, controls, and practices to manage risks, particularly strong reserve management practices.

The Interpretive Letter follows the patterns of previous interpretive letters, authorizing the modern, technological activity by determining that is functionally equivalent to traditional banking activities. Banks’ role as a financial intermediary is entrenched in both legal precedent and history. Banks have long enabled the flow of money and credit in many ways, including by payment transmission, borrowing and lending, and participating in capital markets. They are qualified to facilitate the exchange of payments, settle transactions, and serve as an intermediary. Within the role of financial intermediary, banks have evolved to meet new financial demands and technologies. Now in particular, there is increased demand for banks to rely on INVNs to conduct their traditional functions, which will enable faster and more efficient payments. Using INVNs to facilitate payments transactions falls within permissible payment functions of a bank. From the OCC’s perspective, INVN simply provides a new means for old services, such as transmitting payment instructions and validating payments.

Similarly, banks may use stablecoin to facilitate customer payment transactions, including by issuing stablecoin[13] or exchanging stablecoin for fiat currency. According to the Interpretive Letter, stablecoin is simply a mechanism of payment, conveying payment instructions just like a debit card, check, or electronically stored value (ESV) system.[14] Stablecoin, like ESV, may serve as an electronic representation of USD. The distinction between the two is technological only, and the permissibility analysis is the same. Buying, selling, and issuing stablecoin, or serving as a node to validate transactions on the INVN, is permitted to facilitate customer payment transactions.

Benefits and Risks

The Interpretive Letter discusses the benefits and risks of INVNs and stablecoins. As a shared database with multiple nodes that ensure a consensus, INVNs may be more accurate and reliable than other payment networks, less susceptible to failure and tampering. Stablecoins can take advantage of these INVN benefits and enhance efficiency in the payment process, while retaining the relative stability of fiat currency.

Payment activities involving cryptocurrencies may involve risks related to fraud, liquidity, and compliance among others. Banks using these technologies must conduct their activities in a safe and sound manner and in compliance with applicable law, particularly AML and CFT laws.[15] This may require legal and technological expertise, and may further mandate the expansion of a bank’s AML compliance program. The OCC does not consider this an impasse; other electronic activities permitted to banks, such as data processing services, pose similar risks and require similar expertise and adaptation. The OCC simply advises, as emphasized in the 2017 Bulletin, that new activities “should be developed and implemented consistently with sound risk management practices and should align with banks’ overall business plans and strategies.” And, as always, risk management should match the complexity of the product or service offered.

In the Interpretive Letter, the OCC neither encourages nor discourages banks from using INVNs and stablecoins, but recognizes that the growing market and demand for both indicates that banks should evaluate whether adopting these technologies is appropriate to ensure a bank’s ability to provide modern payment services to their customers.

The Bigger Picture

The OCC has been active in the emerging technology sector. On January 13, 2021, the OCC announced its conditional approval of the conversion of Anchorage Trust Company, a South Dakota chartered trust company, to become Anchorage Digital Bank, National Association (“Anchorage”).[16] This is the first national trust charter granted to a cryptocurrency company. Two other cryptocurrency companies have applied to the OCC for national trust bank charters: Paxos National Trust and BitPay, Inc. However, with the resignation of the Acting Comptroller of the Currency Brian Brooks on January 14, 2020, and the impending Biden administration, it is unclear whether or how fast additional charters may be granted to cryptocurrency companies.

Financial institutions might consider that, in the context of INVNs and stablecoins, the OCC is swimming in uncharted waters, ahead of other federal banking regulators.[17] The Federal Deposit Insurance Corporation has not issued guidance. From the Federal Reserve, Governor Lael Brainard has noted some concerns posed by stablecoin.[18] Depending on the jurisdiction, stablecoin may fit into different, even multiple, sectors of a regulatory framework and implicate a patchwork of international AML laws. As for INVNs, Governor Brainard warned they pose data privacy concerns and legal complexity. While the Interpretive Letter provides that, to engage in stablecoin and INVN activities, legal compliance and risk management must be addressed, the challenges of both remain untold. In moving forward, early-adopting financial institutions will likely face new, complex challenges, as will their examiners.

[1] See, e.g., Chief Innovation Officer Discusses OCC Support of Responsible Innovation(June 25, 2019).

[2] President’s Working Grp. on Fin. Markets Releases Statement on Key Regulatory & Supervisory Issues Relevant to Certain Stablecoins, Treas. SM-1223 (Dec. 23, 2020).

[3] The Interpretive Letter discusses two main categories of nodes: Full nodes, which contain a full copy of the ledger’s history and maintain the consensus between nodes, and light nodes, such as digital wallets, which do not contain a full copy of the ledger’s history. Financial institutions generally serve as full nodes.

[4] For general background on the treatment of stablecoins under U.S. Federal and State laws and regulations, please see our recent publication, Stablecoin Regulation in The United States (November 2, 2020).

[5] New, Modified, or Expanded Bank Products and Services: Risk Management Principles, OCC Bulletin 2017-43.

[6] OCC Interpretive Letter 1170 (Jul. 22, 2020). IL 1170 lists multiple services that national banks may provide in connection with custodying cryptocurrency, which include facilitating the customer’s cryptocurrency and fiat currency exchange transactions, transaction settlement, trade execution, recording keeping, valuation, tax services, and reporting, among others.

[7] 12 CFR Part 7.28.

[8] Joint Statement on Risk-Focused Bank Secrecy Act/Anti-Money Laundering Supervision (July 22, 2019). For more information on this joint statement, please see our Client Alert.

[9] OCC Interpretive Letter 1172 (Sept. 21, 2020).

[10] A wallet is a program that stores the cryptographic keys associated with a particular unit of digital currency. In a hosted wallet, the keys are stored by a third party that stores and transmits cryptocurrency transactions on the accountholder’s behalf. In an unhosted wallet, the owner of the cryptocurrency holds the keys and controls the cryptocurrency in the wallet.

[11] See footnote 17 of the Interpretive Letter.

[12] FSAs are also permitted to engage in payment-related activities, to transfer customer funds by electronic means, and to use electronic means or facilities to provide products, services, or functions as part of an authorized activity. 12 C.F.R. § 145.17; 12 C.F.R. § 155.200.

[13] The Interpretive Letter cautions that issuing stablecoins must comply with all securities laws and regulations.

[14] The Interpretive Letter discusses ESV systems at length. In permitting national banks to offer ESV systems, the OCC recognized that creating, selling and redeeming ESV for USD is within the business of banking, and is the electronic equivalent of paper-based payment devices. Issuing and redeeming ESV is the equivalent of issuing and circulating notes. Clearing and settling ESV is no different from transactions that banks perform with travelers checks or credit and debit cards.

[15] As bad actors may rely on cryptocurrencies to engage in illicit activity and avoid the traditional financial system, the OCC notes that strict compliance with AML and CFT laws is particularly important in this area.

[16] OCC Conditionally Approves Conversion of Anchorage Digital Bank (January 13, 2021).

[17] Note that the OCC is not alone in comparison to state regulators. The New York Department of Financial Services (NYDFS) has granted numerous virtual currency licenses under its “BitLicense” regulation (23 NYCRR Part 200) or limited purpose trust company provisions of the New York Banking Law. Recently, the NYDFS has issued authorizations for limited purpose trust companies and limited liability companies to offer stablecoins, including to Gemini Trust Company LLC, Paxos Trust Company, and GMO-Z.com Trust Company Inc.

[18] Governor Lael Brainard, Digital Currencies, Stablecoins, and the Evolving Payments Landscape (October 16, 2019).