Bitcoin surges, and the American banking industry "can't sit still."

Author: Tuo Luo Finance

During the Spring Festival, the Chinese people are immersed in family joy, while the crypto market is hard to calm.

On one hand, thanks to the influx of funds brought by spot ETFs, Bitcoin has reversed its previous downward trend, showing strong performance, starting to recover its previous price differences, and on February 14, it broke through $50,000, reaching a new high since December 2021, later maintaining fluctuations around $51,000.

On the other hand, the highly anticipated Coinbase Q4 financial report was released, showing Q4 revenue of $954 million, achieving quarterly profitability for the first time in two years. Year-on-year, Coinbase's custodial asset inflow reached $7 billion, with custodial assets totaling $101 billion by the end of the year. According to its CEO, Coinbase currently holds 90% of the $37 billion Bitcoin ETF assets, but this revenue was not included in Q4, meaning its custodial income will further increase in the 2024 fiscal year.

While Bitcoin prices continue to hit new highs, Coinbase is visibly thriving, and all of this seems unrelated to the traditional American banking industry, which is most aligned with public perception and primarily engaged in "custody" services.

Against this backdrop, American banks can no longer sit still.

Bitcoin Soars, Coinbase Financial Report Shines

February coincides with the vibrant Chinese New Year, and Bitcoin seems to have caught this wave of blessings. During the Spring Festival, Bitcoin experienced a surge, reaching $47,000 on February 9, breaking through $48,000 on February 11, and surpassing $50,000 on February 14, even peaking at $52,700, before continuing to fluctuate around $51,000, currently reported at $51,624, with a 7-day increase of over 26%.

Bitcoin price trend, source: Binance

From the market perspective, regarding the reasons for the rise, although the halving is approaching, it mainly stems from the net inflow of funds brought by Bitcoin spot ETFs. According to data, as of February 15, the total holdings of 11 ETFs in Bitcoin have exceeded 720,000 coins. Although Grayscale is still in a selling state, with a total outflow of 15.97 coins, other ETFs are in an inflow state. According to CoinShares' research director James Butterfill's post on platform X, as of February 14, the total net inflow of U.S. spot Bitcoin ETFs has surpassed $4 billion. BitMEX Research data shows that the net inflow of Bitcoin spot ETFs last week was $2.2734 billion, with a total net inflow of $4.9269 billion since January 11.

Coincidentally, Coinbase's Q4 financial report was also released after the market closed on February 16, and overall, the report is undoubtedly impressive. Affected by high compliance costs and regulations, Coinbase's performance after going public has been far inferior to that of large offshore exchanges like Binance, especially in the past two years, where the market downturn directly led to a dual decline in Coinbase's performance and stock price. However, in the last quarter of 2023, Coinbase finally welcomed a rare perfect ending.

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

Coinbase earnings situation, source: Coinbase official website

Delving into the financial report, Coinbase's revenue is mainly divided into two parts: trading revenue and subscription and service revenue. From the perspective of trading revenue, due to the relatively sluggish cryptocurrency market last year, Coinbase's annual trading revenue still showed a downward trend, with total trading revenue for 2023 being $1.5 billion, a year-on-year decrease of 36%. Total trading volume was $468 billion, down 44% year-on-year; retail trading volume was $75 billion, down 55% year-on-year; and institutional trading volume was $393 billion, down 41% year-on-year.

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

Coinbase subscription and service revenue situation, source: Coinbase official website

It is worth noting that in this financial report, the highly anticipated Bitcoin ETF custodial income was not included, as the ETF was approved in January 2024. As the custodian for 8 of the 11 spot Bitcoin ETFs, it currently holds about 90% of the ETF assets, and this income will be disclosed in Q1 2024, indicating that Coinbase's revenue still has significant growth potential. In fact, according to the CEO, the company expects first-quarter subscription and service revenue to be between $410 million and $480 million.

As Bitcoin continues to grow, the corresponding direct institutional revenue is also becoming increasingly prominent, which undoubtedly has drawn the "green-eyed" attention of other institutions. The American banking industry, which had previously been skeptical about crypto, can no longer sit idly by, as custodial services are a major source of income for many banks.

From a timeline perspective, before 2020, only specific crypto custodians could provide cryptocurrency custody services, and they needed to be issued trust charters by national financial regulatory agencies, making the process complex and cumbersome. At that time, although there were no actual laws or regulations prohibiting banks from custodying cryptocurrencies, very few banks engaged in this field due to risk and scale considerations.

This situation improved on July 22, 2020, when the Office of the Comptroller of the Currency (OCC), an independent agency under the U.S. Treasury, issued a public letter clarifying that national banks and federal savings associations have the legal right to custody cryptocurrency assets. Subsequently, several banks, led by BNY Mellon, began to venture into crypto asset custody services.

However, this good situation did not last long. After experiencing the FTX incident in 2022, U.S. authorities realized that the risks associated with crypto assets could potentially transfer to systemic risks, leading to a rapid tightening of crypto regulation. The three major federal banking regulatory agencies issued a joint statement emphasizing the risks of crypto assets to banking institutions, implying that banks should not engage in crypto-related businesses. In January 2023, the Federal Reserve Board (FRB) decided to reject applications for custody banks focused on cryptocurrencies. Since 2022, the consensus among banking regulators regarding the risks of cryptocurrencies and their exposure in the financial system has become cautious and skeptical, until the approval of Bitcoin spot ETFs this year.

On February 14 of this year, SEC Chairman Gary Gensler received a special Valentine's Day letter. This letter was sent by the Bank Policy Institute, the American Bankers Association, the Securities Industry and Financial Markets Association, and the Financial Services Forum, requesting him to amend Staff Accounting Bulletin (SAB) 121 to improve the restricted situation of cryptocurrencies in the banking industry.

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

This bulletin was issued by the SEC on April 11, 2022, and it regulates cryptocurrency custody, requiring financial institutions, credit unions, and banks providing crypto custody services to retain a certain amount of funds to support their clients' digital assets. In simple terms, to ensure transparency, custodians need to account for crypto assets in the liabilities section of their balance sheets, and to ensure balance, the assets section should also increase by the same amount, which undoubtedly increases the custody costs for custodians and violates the basic principle of treating assets equally.

The letter explicitly expressed dissatisfaction with this provision, arguing that regulated banking organizations are being prevented from providing digital asset protection services on a large scale, negatively impacting investors, clients, and the overall financial system. It also emphasized that the balance sheet requirements, combined with the overly broad definition of "crypto assets" in SAB 121, would have a chilling effect on banks' ability to develop distributed ledger technology (DLT) applications.

The SEC, of course, did not agree, stating that accounting guidance is necessary, and that crypto assets have unique risks and uncertainties compared to other assets held by banks for clients, making transparency and risk hedging important. Gary Gensler even stated in an interview that "the cryptocurrency industry lacks appropriate and necessary disclosures related to securities."

In fact, it is not only the banking industry that has expressed dissatisfaction with this regulation; the differing attitudes towards crypto between the two parties have also made this regulation face significant controversy.

As early as August 2022, Senator Lummis wrote to the U.S. Comptroller General, questioning whether the regulation complies with the rules set forth in the Congressional Review Act. Subsequently, in January 2023, Cynthia Lummis, along with U.S. Representatives Mike Flood and Wiley Nickel, proposed a resolution again, declaring that the announcement has no legal effect. Up until November 2023, resistance to SAB 121 has not ceased, with congressional memos requesting clarification of the Government Accountability Office (GAO) investigation results and questioning its enforceability.

From the current results, although the game of interests between both sides continues, the attitude has been clearly expressed. Compared to the previous dismissive attitude, American banks now hope to actively participate in the custody of Bitcoin ETFs, obtaining custody fees and possibly other fees, and have begun to pressure regulators for this purpose.

In the long run, for security reasons, the current situation where only Coinbase dominates is bound to be unsustainable, and the diversification of custodians is also an objective trend. The involvement of mature banks has a positive effect on the development of the crypto industry. On one hand, it can compel custodians to improve security and transparency, reducing custody costs; on the other hand, it also increases the mainstream acceptance of crypto assets. From common sense, banks have always been the most important part of the financial system, and their involvement in crypto will lower the threshold for crypto assets and broaden the channels for public participation.

Of course, accounting regulations will not be adjusted or modified in the short term, and this wave of actions by banks may also seem opportunistic. However, in a world where everyone seeks profit, wanting a share of the pie is not shameful. As Bitcoin gradually enters the mainstream, the reversal of fortunes will become a common sight for onlookers.