Federal Reserve unanimously rejects application from crypto bank Custodia – Ledger Insights

On Friday, the Federal Reserve Board announced that it had rejected the application of Custodia Bank to join the Federal Reserve System. Custodia is a Wyoming state-chartered bank without FDIC insurance. The goal of the special bank is to become a bridge between the digital asset sector and the US dollar payment system.

In addition, the Federal Reserve issued a policy statement proposing to extend restrictions on crypto assets to uninsured state-chartered banks to put them on a level playing field with national banks and FDIC-insured banks.

All seven of the Federal Reserve Board members voted against giving Custodia access to a main account.

The reasons for the Fed’s rejection include proposals for “new and unproven crypto-activities that include the issuance of a crypto-asset on open, public and/or decentralized networks.” In addition, the Federal Reserve said that Custodia’s risk management framework was “inadequate” to address the elevated risks of crypto, particularly AML.

The startup bank first applied to the Federal Reserve for access to a main Fed account more than two years ago and has sued the Federal Reserve over the issue. Without a direct account, it has to go through intermediaries, adding a layer of costs that blockchain aims to address.

“Custodia offered a safe, federally regulated, solvent alternative to the reckless speculators and speculators of crypto who penetrated the US banking system, with disastrous results for some banks,” said Caitlin Long, CEO of Custodia. “Custodia actively sought federal regulation, going beyond all requirements applicable to traditional banks. The Board’s denial is unfortunate, but consistent with the concerns Custodia has raised regarding the Federal Reserve’s handling of its applications, an issue we will continue to address.”

As a special bank, Custodia customer deposits retain 100% coverage as the bank is not allowed to advance loans. It also has its bank-issued digital dollar, Avit.

Given the FTX collapse, other crypto failures and volatility, authorities are cracking down on the sector and trying to keep the links between the crypto and banking sectors to a minimum.

However, Custodia’s founder Caitlin Long has a very thoughtful approach to the sector. Since launching Custodia in 2020, she has been committed to providing a regulated path for the digital asset sector. Prior to her involvement in the crypto world, her resume included a nine-year stint at Morgan Stanley, followed by ten years at Credit Suisse.

In April, Long commented, “”Bitcoin is going to take down a G-SIB (global systemically important bank) at some point because they don’t understand that the settlement risk is so different between Bitcoin and traditional assets.”

Federal Reserve Crypto Proposal for Uninsured State Banks

Friday’s Federal Reserve publication was a draft policy statement. It aims to prevent state-owned banks from holding most cryptocurrencies. In the case of stablecoins, banks will need a no-objection letter from the Federal Reserve and have adequate controls in place.

From a legal perspective, the Federal Reserve can impose banking restrictions on nationally chartered banks. Because FDIC-insured banks have similar restrictions to national banks, any national banking restrictions also apply to them. The Federal Reserve says under the Federal Reserve Act that it can impose discretionary restrictions on state-controlled banks, and this is being used for crypto restrictions.

To date, two Federal Reserve member banks have had significant crypto exposures, both of which have served as significant entry and exit points for the digital asset sector. The smaller Silvergate announced a quarterly loss of $1 billion, but managed to survive a massive drop in deposits from its digital asset clients. It also offered a variety of services, including a limited amount of crypto-backed lending. The share price is just over a tenth of the figure compared to May 2022, before the crypto crash.

The larger Signature Bank was already quite diversified, but it recently announced that it would reduce its exposure to the digital asset sector.