Crypto Bank Custodia Takes on the Fed—Here’s Everything You Need to Know

On the eve of the Federal Reserve Board’s deadline last week to reconsider Custodia Bank’s application to become a member institution, CEO and founder Caitlin Long said. Decrypt she doubted it would be approved.

She was right.

The Fed rejected the application, saying in a brief announcement that Custodia’s business plan is “inconsistent with the necessary factors under the law.” When the board initially rejected the application on January 27, it was more specific: “The company’s new business model and proposed focus on crypto assets pose significant security and solvency risks.”

But there was other news as well. U.S. District Judge Scott Skavdahl denied a motion to have Custodia’s lawsuit against the Fed dismissed. That makes it more likely (but does not guarantee) that the question of whether the Kansas City Federal Reserve handled Custodia’s application properly will be answered in court.

“From our perspective, we were pushed into this,” Long said of the lawsuit.

The bank is a Wyoming-chartered special purpose depository, meaning it can deposit crypto on behalf of its customers. It originally submitted its application for a federal master account in October 2020, a month after San Francisco-based crypto exchange Kraken did the same for its own crypto bank. In early 2021, a Kansas City Fed representative told Custodia that the application contained “no showstoppers,” according to the lawsuit.

At the time, Long believed a decision was imminent.

Getting a master account would give Custodia access to the FedWire network, which handled roughly 200 million transfers for its 4,700 member institutions last year. It is specially designed for large sums of money to travel from one bank to another. In 2022, FedWire transfers exceeded $1 quadrillion for the first time since its inception in 1987.

If Custodia gained access to FedWire, it would eliminate the need for the crypto bank to broker an agreement with an intermediary to handle large transactions with other institutions on its behalf. Without the need for a third party, which would undoubtedly charge a fee, Custodia could offer competitive rates to its large institutional clients.

By June 2022, more than a year after the “no showstoppers” comment, Custodia had still not received a decision on the application. The bank filed suit against the Kansas City Fed and the Federal Reserve Board of Governors for the “patently unlawful delay.” Then in January, the Kansas City Fed formally rejected Custodia’s application and, after being asked to consider a revised business plan, doubled down on the decision last week.

For banks that don’t have their roots in the crypto industry, decisions about main accounts usually come within days, attorney Jason Finger of the Proskauer Rose law firm told me. Decrypt in an email.

“Traditional financial firms typically receive approval on their application for a main account at the Federal Reserve within days. Absent crypto-focused congressional legislation, federal regulators are taking a patchwork approach to studying and regulating crypto,” he said. “A final public resolution of this case should provide much-needed clarity to crypto firms applying for main accounts at the Federal Reserve, which in Custodia’s case took two years to reject.”

The Kansas City Fed has argued that the rejection, no matter how late, renders Custodia’s complaint against it irrelevant. But now that a judge has said he disagrees, Custodia may have his day in court.

“We believe this is the first case in which claims seeking to compel assignment of a master account have gone beyond the motion to dismiss stage,” attorneys David Gassett, Stephen Gannon and Lisa Richards of the Davis Wright Tremaine law firm wrote in a blog post. “The court’s emphasis on the importance of developing the factual record should be of substantial benefit to Custodia, as defendant’s delay appears excessive on its face.”

DWT is the same law firm that wrote an amicus brief in support of Custodia Bank on behalf of the Wyoming Select Committee on Blockchain Technology.

In doing so, Wyoming’s blockchain committee joined Republican lawmakers, including Sens. Cynthia Lummis (R-WY), Steve Daines (R-MT) and Kevin Cramer (R-ND), who filed their own amicus brief in support of Custodia Bank in September.

When she spoke to Decrypt last week, Long said Custodia’s path has been a lonely one. The way she sees it, the rest of the crypto industry has either stayed offshore to avoid unclear rules in the US or decided to move forward without clear rules.

“We’re in the third group and we’re pretty much on our own. We’ve asked permission for everything and we didn’t get permission. And then what we did when we didn’t get the permission, which was confirmed at the same time as the refusal, we said that we cut out things that they didn’t give us permission to do and we resubmitted the business plan.”

That included dropping plans to launch a stablecoin, which the Fed specifically cited when it first rejected Custodia’s application. But of course it didn’t work.

In October, as her legal team fought the first of two now-rejected motions to have Custodia’s lawsuit dismissed, Fed-regulated Wall Street stalwart BNY Mellon announced it was launching Bitcoin and Ethereum custody services.

Days later at a conference, Long blasted the Fed for what she called hypocrisy in calling Custodia Bank’s crypto focus risky but allowing BNY Mellon to launch its own crypto product.

So when crypto exchange FTX collapsed amid allegations of fraud and mixed funds in November, Long realized her efforts to warn regulators about bad actors in the industry had fallen on deaf ears.

Last month, she wrote in a blog post that she “turned over evidence to law enforcement authorities of probable crimes committed by a major crypto scam” months before a wave of crypto market contagion wipes out billions of dollars in value in 2022.

She took particular exception with a speech in which Sen. Dick Durbin (D-IL) compared Custodia to “a 29-year-old accused fraudster who now wears an ankle bracelet.”

“The reality is I was never at the table with the decision makers,” Long said. “Jay Powell and Gary Gensler were only too happy to have meetings with Sam Bankman-Fried, but every time I requested similar meetings, including with Powell, I was turned down.”