The Federal Reserve says Custodia’s crypto-focused business model is “inconsistent” with approval

The Federal Reserve Board argued that Custodia Bank’s proposed business model was “inconsistent” with approval in an order explaining its rejection of the Wyoming-based crypto bank’s application for membership.

Custodia’s application for membership, as well as its application for a main account, was rejected in January, 18 months after the applications were originally submitted. Custodia, formerly known as Avanti Bank, filed suit against the Federal Reserve in June 2022, alleging the central bank illegally delayed its decision, and filed an amended complaint earlier this year alleging a Fed conspiracy to block it.

At the time of Custodia’s rejection, the Federal Reserve issued a brief statement explaining its position that Custodia’s “new business model and proposed focus on cryptoassets posed significant security and soundness risks” and that the bank did not have an adequate risk management framework. to address crypto-related risks such as money laundering and terrorist financing.

However, Friday’s 86-page publication is the first time the central bank has expanded its reasons for the refusal. The FRB claimed that Custodia had inadequate risk management and controls, “particularly with regard to overall risk management; compliance with the Bank Secrecy Act and US sanctions … financial projections, and liquidity risk management practices.”

The board also argued that Custodia’s revenue model, which “depends almost exclusively on the existence of an active and vibrant market for cryptoassets” makes it vulnerable to market volatility, although the board admitted that “Custodia appears to have sufficient capital and resources to maintain the first operation.”

“Recent events, including the bankruptcies of cryptoasset intermediaries Celsius, Voyager, BlockFi and FTX, have highlighted that the global and largely unregulated or non-compliant cryptoasset sector lacks stability and that dislocations in the sector could stress financial institutions focused on serve the crypto asset sector,” the board reasoned.

Aside from its other concerns, the board argued that Custodia’s financial plans were “so unfavorable that they provide sufficient grounds in themselves to justify denial of the application,” a statement it repeated while detailing various aspects of Custodia’s application that it objected to.

Custodia has pushed back against the Fed’s rejection, both through the ongoing lawsuit and in a statement Friday that called the order “the result of a series of procedural abnormalities, factual inaccuracies that the Fed refused to correct, and general bias against digital assets.”

“Rather than choosing to work with a bank that uses a low-risk, fully-reserved business model, the Fed instead demonstrated its short-sightedness and inability to adapt to changing markets,” the Custodia statement said. “Perhaps more attention to areas of real risk would have prevented the bank closures that Custodia was created to avoid. It is a shame that Custodia has to go to court to defend its rights and force the Fed to comply with the law.”

The membership was refused without prejudice, which means that in theory Custodia will be able to apply for membership again in the future.