Republic First Bank Closure the Best Possible Narrative for Crypto?

While many crypto fans believe turbulent times for the traditional banking industry could be good for digital assets, crypto mixers and self-custody wallets are still being scrutinized by regulators in the U.S.

The United States has seen its first banking failure of 2024 after the closure of Republic First Bank. This once again started discussions in the crypto community about the advantages of cryptocurrencies over traditional banking. While banks have been struggling, the U.S. crypto landscape has also been facing regulatory challenges. Acinq and zkSNACKs announced that they will be exiting the U.S. market after increased regulatory actions against crypto services. Additionally, legal issues also continue to cloud the sector, with the ongoing legal battle surrounding Tornado Cash's co-founder, Roman Storm. Meanwhile, the DTCC decided to cut collateral for crypto ETFs.

Republic First Bank Closes

The United States has seen its first banking failure of 2024 with the closure of Philadelphia-based Republic First Bank. The Pennsylvania Department of Banking and Securities seized control of the bank on Apr. 26, and the Federal Deposit Insurance Corporation (FDIC) has been appointed as its receiver.

According to the FDIC, the agency will manage almost all deposits and buy all assets of Republic Bank. The bank reported having approximately $6 billion in total assets and $4 billion in total deposits on Jan. 31. After the closure, the bank’s 32 branches across New Jersey, Pennsylvania, and New York reopened under Fulton Bank on Apr. 27.

Naturally, this caught the attention of the crypto community and started discussions in the industry about the possible implications of this on digital currencies. Zesh’s Marius Martocsan used Republik First Bank’s closure as an opportunity to reiterate his preference for Bitcoin over traditional banks.

Meanwhile, a pseudonymous crypto trader known as Pillage Capital believes the situation is a beneficial narrative for promoting cryptocurrencies. Crypto commentator Randi Hipper also had a discussion with his own followers about the independence offered by cryptocurrencies in contrast to traditional banking.

The banking sector has been through quite a tough period, with five banks failing in the U.S. during 2023 alone, including high-profile closures like those of Signature Bank and Silicon Valley Bank, which were both attributed to systemic risks by regulatory authorities. These banking challenges have stirred many debates about the stability of financial institutions and the potential role of cryptocurrencies as alternative financial tools.

Acinq and zkSNACKs Exit US Market

On the other hand, it is not only traditional financial institutions that are going through turbulent times. Acinq’s Bitcoin wallet, Phoenix Wallet, and zkSNACKs, two self-custody crypto wallet providers, are both discontinuing their services for customers in the United States. This comes after recent regulatory actions against other major entities in the crypto space, like Consensys and Samourai Wallet. These actions have raised many concerns about the classification and regulation of self-custodial wallets, Lightning service providers, and even Lightning nodes as Money Services Businesses under U.S. law.

zkSNACKs announced on Apr. 27 that it would strictly prohibit U.S. users from accessing its services, effective immediately. Similarly, Acinq informed users of its Phoenix Wallet through an Apr. 26 post that they have until May 2 to adjust to the changes and also advised them to drain their wallets without force-closing to avoid high on-chain fees.

There have been many discussions worldwide about the role of self-custody crypto wallets in potentially facilitating illicit activities like money laundering. The heightened scrutiny was exemplified by a Wells notice issued to Consensys on Apr. 10 by the SEC, signaling potential enforcement actions related to its MetaMask products for operating as an unregistered broker-dealer.

The arrest of Samourai Wallet’s co-founders on charges of money laundering and operating an unlicensed money transmitting business on Apr. 24 further cemented the idea that the U.S. government is increasing oversight of crypto-related activities.

In contrast, European regulators have recently shown a much more lenient approach towards self-custody crypto wallets. A proposal to impose a 1,000 euro limit on transactions from these wallets was scrapped by the European Parliament, although crypto exchanges are required to perform identity verification checks for transactions exceeding this amount.

Similarly, crypto mixers are also in legal hot water. The U.S. Department of Justice (DOJ) opposed a motion to dismiss charges against Roman Storm, the co-founder of Tornado Cash. Storm was arrested and released on a $2 million bond, and is facing serious accusations of money laundering, operating an unlicensed money transmitter, and violating sanctions. The DOJ's response to Storm’s legal challenge argues that his case contains disputed facts that should be determined by a jury, rather than dismissed at an early stage.

Prosecutors hold firm that Tornado Cash, which was launched in 2019, provided tools that made it possible for users, including groups like North Korea’s Lazarus Group, to launder funds anonymously. The service includes a website, user interface, smart contracts, and a network of relayers. Despite claims from Storm’s defense that he only contributed to the code and had no control over its usage, the DOJ is still convinced that he played a crucial role in operating and managing the service.

In their defense, Storm's attorneys argued that Tornado Cash does not function as a traditional financial institution and therefore does not meet the regulatory definitions that would subject it to certain legal standards. They also pointed out that the service’s design does not allow any single entity, including its creators, to control or prevent its misuse by parties like the Lazarus Group.

What Happened with Tornado Cash?

Tornado Cash is a decentralized protocol designed for Ethereum blockchain users who are looking for more privacy in their transactions. On blockchains like Ethereum, while identities are pseudonymous, transactions are still traceable, making it possible for anyone to monitor activities if they link a person to a specific wallet.

Centralized exchanges must comply with KYC and AML regulations, meaning a data breach could expose user identities along with their transaction histories. Privacy-focused cryptocurrencies like Monero and ZCash address this issue on their respective networks but don't extend this privacy to other blockchains, which led to the development of Tornado Cash.

On Aug. 8 of 2022, the U.S. Treasury sanctioned Tornado Cash, accusing it of failing to implement controls to prevent money laundering by malicious actors, including North Korea's Lazarus Group, which has been involved in many very high profile thefts. The Treasury's Office of Foreign Asset Control (OFAC) banned U.S. crypto users and businesses from interacting with Tornado Cash, claiming it had been used to launder around $7 billion in cryptocurrency since 2019.

The sanctions had immediate and major impacts on the crypto space. The Treasury banned numerous Ethereum and USDC wallets associated with Tornado Cash, and entities like GitHub, which suspended accounts linked to Tornado developers, were compliant with the sanctions.

The sanctions extend to all U.S. individuals and entities, requiring them to report any dealings with Tornado Cash-related assets and making any transactions with these assets illegal in the U.S.

DTCC Cuts Collateral for Crypto ETFs

The Depository Trust and Clearing Corporation (DTCC) announced a major shift in its approach to collateral allocation, affecting financial instruments tied to cryptocurrencies. Starting from Apr. 30, 2024, the DTCC will no longer assign collateral value to exchange-traded funds (ETFs) that have exposure to Bitcoin or other cryptocurrencies.

This move will effectively reduce the collateral value of these ETFs to zero during its annual line-of-credit facility renewal. This decision only impacts the settlement between entities within the line of credit system and does not influence the broader use of crypto ETFs for lending or as collateral in brokerage activities, which will continue based on individual brokers' risk assessments.

Despite DTCC's conservative stance, other traditional financial players are becoming more engaged with cryptocurrency. In fact, Goldman Sachs has seen a resurgence of client interest in cryptocurrencies in 2024, after the U.S. approval of spot Bitcoin ETFs. These ETFs have attracted quite a bit of attention and investment, accumulating more than $12.5 billion in assets under management within just three months of their launch. This surge in institutional interest was particularly evident in February when 75% of new Bitcoin investments were attributed to these newly approved ETFs.

However, the initial enthusiasm has been decreasing. Recent data indicates a slowdown in net inflows to these ETFs, with multiple issuers reporting big outflows. On Apr. 25, there was a net outflow of $218 million from U.S.-based spot Bitcoin ETFs, after a $120 million outflow the previous day.