Crypto Promises of FDIC Protection Under Scrutiny
Voyager Digital Censured in July Over Deposit-Insurance Claims
By Kathy Chu, TruthDAO
In its recent rebuke of bankrupt Voyager Digital, federal regulators spotlighted a common practice in the crypto industry: promising FDIC protection of funds when, in fact, consumers may be fully exposed.
In late July, the Federal Deposit Insurance Corp. (FDIC) and the Federal Reserve issued a cease-and-desist letter to Voyager, ordering the company to stop making “false and misleading” statements that suggest depositors’ funds are insured if Voyager fails. Voyager, on its website, said it has worked with the FDIC to clarify its language about deposit insurance.
FDIC insurance, which has been around since the 1930s, protects deposits of up to $250,000 per individual, but only if banks participating in its insurance program fail. Protection generally does not extend to crypto companies, at least for now. While some deposits with crypto firms may be eligible for a type of protection called "pass-through” FDIC insurance, the benefit is far from automatic. Each claim is analyzed by the FDIC on a case-by-case basis, experts say. No guarantees, in other words.
Even so, Voyager and other crypto lenders have consistently -- and openly -- suggested in their marketing materials and user agreements that depositors' funds may automatically be entitled to FDIC protection. These assurances also show up in social media postings, creating the impression that depositors' funds are more secure than they actually are, experts point out.
“Misrepresentations are real. They’re out there," said Alexandra Steinberg Barrage, a former associate director at the FDIC who now represents crypto companies as a partner at the Davis Wright Tremaine law firm in Washington D.C.
Education, she argues, is the key: “There needs to be a much more heightened awareness of the consequences of misrepresenting FDIC insurance.”
The FDIC declined to comment on whether it is investigating other crypto firms’ claims about deposit insurance. The agency “can’t speak to this at the moment,” a spokeswoman said.
The gap between marketing claims and insurance reality is a dangerous place for consumers. Here's why: Those who are seeking high yields may find out later -- sometimes after the crypto company goes bust -- that their money is not actually protected by FDIC insurance, warns Steven Kelly, a senior research associate at the Yale School of Management.
Kelly, who is an expert in financial crises and systemic risk in the United States, says misstatements by crypto companies aren't helping. These communication failures, he said, are also giving the crypto industry a black eye: They're “bad risk management and bad legal management."
As it concerns Voyager, both the FDIC and the Federal Reserve said depositors who relied on the crypto broker’s marketing "representations" were likely harmed. Voyager froze customer withdrawals in early July, and a week later, filed for Chapter 11 bankruptcy. At the time, it had 3.5 million users and more than $5.9 billion in crypto assets. People who didn't withdraw their funds prior to the freeze were basically stuck -- and could potentially lose much, if not all, of their money.
Joy Dai and David Hu were in that group. In a letter to Judge Michael Wiles, who is overseeing Voyager’s bankruptcy case, Dai and Zhu said Voyager's claims about deposit insurance led them to believe that their money was safe. “As such me and my husband left our lifetime savings in USD with Voyager as we considered it as a traditional bank,” the couple wrote about their $110,000 in deposits with Voyager.
The Voyager case grabbed headlines worldwide, but the FDIC has quietly been moving in this direction for a while.
Citing the rising number of false or misleading claims about deposit insurance, the FDIC in May approved its first-ever rule that dealt with false representations about deposit insurance. The rule, which was released with little fanfare, clarified how the agency would determine violations of the Federal Deposit Insurance Act. It also established a process for pursuing them.
The FDIC did not call out crypto companies specifically, but concerns about the industry appear to be a major factor. At the time, Acting Comptroller of the Currency Michael Hsu said the rule is “especially important in light of the growth of nonbank crypto firms and fintechs,” as consumers may be confused by the nature of their association with banks that offer deposit insurance.
Rohit Chopra, director of the Consumer Financial Protection Bureau, said the agency was particularly concerned about misrepresentations of federal deposit insurance related to stablecoins and other novel crypto assets. Such misrepresentations, he said, even if unintentional, could violate the Consumer Financial Protection Act, which prohibits unfair or deceptive financial practices.
Not surprisingly, scrutiny of Voyager’s collapse — and the company’s claims about FDIC insurance — have been a hot topic on Twitter and Reddit.
In mid-July, Brett Harrison, president of crypto derivatives exchange FTX’s U.S. arm, tried to clear up confusion about how FDIC insurance applies to his firm. Harrison wrote on Twitter that direct deposits from employers to FTX US “are stored in individually FDIC-insured bank accounts in the users' names.” That means customers are the beneficiaries of FDIC insurance at the partner bank, Harrison explained.
Twitter users were quick to point out that the firm's customer agreement states that accounts are "not subject to protections or insurance provided by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation." Frances Coppola, a U.K.-based analyst and economist who is well known in the crypto sphere, also weighed in: “Has FDIC confirmed this?” She further noted that "the rules for passthrough insurance are extremely strict.”
FTX didn’t respond to requests for comment.
Meantime, a spot check of crypto companies suggests that crypto firms are continuing to beat the FDIC drum.
Online brokerage eToro, on the “help center” section of its website, says U.S. residents’ cash holdings “are FDIC insured for up to $250,000 and held in an FDIC-insured custodial account.” eToro’s customer agreement, which can be downloaded, says FDIC insurance applies in the case of a failure by the member bank -- not the failure of eToro. The names of banking partners are not identified. According to FDIC rules, "nonbank entities must identify" where they may place depositors' funds.
eToro spokeswoman Alicia McCauley confirmed that the company doesn’t disclose the names of partner banks. She said customer-service teams can answer customers’ questions about cash deposits.
Keen to the added regulatory scrutiny, perhaps, some companies appear to be rethinking their language around FDIC insurance.
Crypto exchange CEX.IO said in a 2019 blog that “all United States residents’ USD funds are covered by FDIC insurance, up to a maximum of $250,000 per person.” After being contacted for comment, a CEX spokeswoman said the exchange has “reviewed the blog post in question and we will be making some updates to it.”