Bitcoin surges as U.S. banking industry gets anxious

During the Spring Festival, while Chinese people were immersed in family happiness, the crypto market was far from calm.

On the one hand, thanks to the increase in funds brought by spot ETFs, Bitcoin reversed its previous downward trend and continued to perform strongly. It began to recover the previous price difference and broke through US$50,000 on February 14, setting a new high since December 2021. It then fluctuated around US$51,000.

On the other hand, the much-anticipated Coinbase Q4 financial report was released, with Q4 revenue reaching $954 million, achieving quarterly profits for the first time in two years. On an annual basis, Coinbase's custody asset inflow was $7 billion, and the custody assets were $101 billion at the end of the year. According to its CEO, Coinbase currently custody 90% of the $37 billion Bitcoin ETF assets, but this income was not included in the Q4 quarter, so its custody income will increase further in fiscal 2024.

On the one hand, the price of Bitcoin continues to hit new highs, and on the other hand, Coinbase is making visibly huge profits. All of this seems to have nothing to do with the traditional American banking industry, which is most consistent with the public's impression and has "custody" as one of its main businesses.

Against this backdrop, American banks finally could no longer sit still.

Bitcoin surges, Coinbase reports impressive earnings

February was the Chinese New Year, and Bitcoin seemed to have caught up with the blessing. During the Spring Festival, Bitcoin saw a sharp rise. On February 9, Bitcoin rose to $47,000. On February 11, it broke through $48,000. On February 14, Bitcoin broke through $50,000 and once reached $52,700. It then continued to fluctuate around $51,000 and is now at $51,624, up more than 26% in 7 days.

Bitcoin price trend, source: Binance

From the market perspective, as for the reasons for the rise, although the halving is approaching, it mainly comes from the net inflow of funds brought by Bitcoin spot ETFs. From the data, as of February 15, the total Bitcoin holdings of 11 ETFs have exceeded 720,000. Although Grayscale is still in a state of selling, with a total outflow of 15.97, other ETFs are in a state of inflow. According to a post by James Butterfill, head of research at CoinShares, on the X platform, as of February 14, the total net inflow of US spot Bitcoin ETFs has exceeded US$4 billion. According to BitMEX Research data, Bitcoin spot ETFs had a net inflow of US$2.2734 billion last week, and a total net inflow of US$4.9269 billion since January 11.

Coinbase's Q4 financial report was also released after the market closed on February 16. Overall, the report is undoubtedly very impressive. Affected by high compliance costs and supervision, Coinbase's performance after listing is far inferior to that of large offshore exchanges such as Binance. Especially in the past two years, the market downturn has directly led to a double decline in Coinbase's performance and stock price. However, in the last quarter of 23 years, Coinbase finally ushered in a rare perfect ending.

Affected by the rise of the cryptocurrency market, Coinbase turned losses into profits in the fourth quarter, achieving a net profit of US$273 million, completely reversing the loss of US$557 million in the same period last year. For the whole year, it achieved a net income of US$95 million and an adjusted EBITDA of nearly US$1 billion, with total revenue reaching US$3.1 billion.

Coinbase revenue, source: Coinbase official website

A closer look at the financial report shows that Coinbase's revenue is mainly divided into two parts: trading revenue and subscription and service revenue. In terms of trading revenue, due to the relatively sluggish crypto market last year, Coinbase's trading revenue for the whole year is still showing a downward trend. In 2023, the overall trading revenue was US$1.5 billion, a year-on-year decrease of 36%. The total trading volume was US$468 billion, a year-on-year decrease of 44%; the trading volume of ordinary users was US$75 billion, a year-on-year decrease of 55%, and the trading volume of institutions was US$393 billion, a year-on-year decrease of 41%.

However, the decline in trading revenue was offset by the increase in subscription and service revenue. The total subscription and service revenue for the full year was US$1.4069 billion, with the most significant growth in the fourth quarter, with subscription and service revenue of US$375 million, an increase of 12%. The main drivers of growth were stablecoin revenue, interest income and blockchain rewards (staking and price increase factors). Among them, stablecoin revenue was US$171.6 million, up from US$145.7 million in the same period last year; blockchain rewards were US$95.1 million, up from US$62.4 million in the same period last year; custody fee revenue was US$19.7 million, up from US$11.4 million in the same period last year; interest income was US$42.6 million, up from US$36.5 million in the same period last year; other subscription and service revenue was US$46.5 million, up from US$26.7 million in the same period last year.

Coinbase subscription and service revenue, source: Coinbase official website

It is worth noting that in this financial report, the much-watched Bitcoin ETF custody income was not recorded because the ETF was approved in January 2024. As the custodian of 8 of the 11 spot Bitcoin ETFs, it currently has custody of about 90% of the ETF assets. This income will be disclosed in the first quarter of 2024, which means that Coinbase's revenue still has a lot of room for growth. This is indeed the case. According to the CEO, the company expects subscription and service revenue in the first quarter to be between US$410 million and US$480 million.

Bitcoin continues to grow, and the corresponding direct institutional profits are becoming increasingly prominent, which has undoubtedly attracted the "red eyes" of other institutions. The one that can't sit still is the U.S. banking industry, which has been skeptical about encryption before. After all, from a functional perspective, the business of fund custody is the main source of income for many banks.

From the timeline, before 2020, only specific crypto custodians could provide cryptocurrency custody services, and the trust charter needed to be issued by the national financial regulator, which was complicated and cumbersome. At that time, although there were no actual laws and regulations prohibiting banks from custodying cryptocurrencies, due to risk and volume considerations, very few banks were engaged in this field.

The situation was not improved until July 22, 2020, when the Office of the Comptroller of the Currency (OCC), an independent agency under the U.S. Treasury Department, issued an open letter clarifying that national banks and federal savings associations have the legal right to custody cryptocurrency assets. Since then, a number of banks, led by Bank of New York Mellon, have begun to get involved in the crypto asset custody business.

The good times did not last long. After the FTX incident in 2022, the US authorities realized that there was a possibility that the risks of crypto assets could shift to systemic risks, and crypto regulation was tightened rapidly. The three major federal banking regulators issued a joint statement emphasizing the risks of crypto assets to banking institutions, suggesting that banks should not engage in crypto-related businesses. In January 2023, the Federal Reserve Board (FRB) decided to reject the membership application of a cryptocurrency-focused custodian bank. Since 2022, the consensus that banking regulators are cautious and skeptical about cryptocurrencies and their risk exposure in the financial system has basically penetrated the entire financial industry until the Bitcoin spot ETF was approved this year.

Just on February 14 this year, SEC Chairman Gary Gensler received a special Valentine's Day letter. The letter was sent by the Bank Policy Institute, the American Bankers Association, the Securities Industry and Financial Markets Association, and the Financial Services Forum, asking it to amend Staff Accounting Bulletin (SAB) 121 to improve the situation of cryptocurrency restrictions in the banking industry.

Screenshot of the letter sent by banking institutions to the SEC, source: American Bankers Association official website

The communiqué was issued by the SEC on April 11, 2022. It regulates cryptocurrency custody and requires financial institutions, credit unions, and banks that provide crypto custody services to retain a certain amount of funds to support their customers' digital assets. In simple terms, to ensure transparency, custodians need to include crypto assets in the liability column of the balance sheet, and to ensure the balance of assets and liabilities, the asset column should also be increased by the same amount, which undoubtedly increases the custody costs of custodians and violates the basic principle of treating assets identically.

The letter clearly expressed dissatisfaction with this clause and believed that regulated banking organizations were prevented from providing digital asset protection services on a large scale, and investors, customers and the overall situation of the financial system would be negatively affected. It also emphasized that the on-balance sheet requirements, coupled with the overly broad definition of "crypto assets" in SAB 121, will have a chilling effect on the ability of banking organizations to develop distributed ledger technology (DLT) applications.

The SEC certainly disagrees with this, saying that accounting guidance is necessary. Compared with other assets held by banks for their clients, crypto assets have unique risks and uncertainties, and it is important to maintain transparency and hedge risks. Gary Gensler even bluntly stated in an interview that "the cryptocurrency industry lacks appropriate and necessary disclosures related to securities."

In fact, it is not just the banking industry that has expressed dissatisfaction with the regulation. The different attitudes between the two parties towards encryption have also made the regulation face huge controversy.

As early as August 2003, Senator Lummis sent a letter to the US Comptroller General questioning whether the regulation complies with the rules of the Congressional Review Act. Later in January 2004, Cynthia Lummis and US Representatives Mike Flood and Wiley Nickel again proposed a resolution to rule that the announcement has no legal effect. Until November 2004, the resistance to SAB 121 has not stopped, and a memorandum from members of Congress requested clarification of the findings of the Government Accountability Office (GAO) and questioned its enforceability.

Judging from the current results, although the game between the two parties with interests is still going on, the attitude has been expressed very clearly. Compared with the previous dismissive attitude, the current US banks are more willing to actively participate in the custody of Bitcoin ETFs, obtain custody fees and possible other fees, and have begun to put pressure on regulators for this purpose.

In the long run, for security reasons, the current situation where Coinbase is the only dominant player is bound to be unsustainable, and the increasing diversity of custodians is also an objective trend. The involvement of mature banks has a positive effect on the development of the crypto industry. On the one hand, it can force custodians to improve security and transparency and reduce custody costs; on the other hand, this move has once again increased the mainstream of crypto assets. From a common sense point of view, banks have always been the most important part of the financial system. Banks' access to crypto will once again lower the threshold for crypto assets and broaden channels for public participation.

Of course, accounting regulations will not be adjusted in the short term, and the bank's operation is inevitably suspected of being eager for quick success, but the world is bustling and everyone is motivated by profit, so it is not shameful to want a piece of the pie. As Bitcoin gradually enters the mainstream, the reversal of thirty years in the east and thirty years in the west will eventually become commonplace.