Within a few hours on Jan. 27, Wyoming’s goal of becoming a worldwide leader in banking and crypto assets through the establishment of special purpose depository institutions became the target of three announcements from the White House and the Federal Reserve Board.
Simultaneously, the Federal Reserve Board announced that it had denied the application by Custodia Bank Inc. of Cheyenne to become a member of the Federal Reserve System and released a policy statement tightening rules on banks with or without deposit insurance. In a blog post, the White House stated its commitment to assuring increased safeguards are put in place to “ensure that new technologies are secure and beneficial to all — and that the new digital economy works for the many, not just the few.”
Custodia Bank, one of the first SPDIs established in the state, is still engaged in a lawsuit it filed in 2022 against the Federal Reserve and the Federal Reserve Bank of Kansas City over the lack of action in its application for a master account in 2019. Custodia alleges the lack of Fed action violated a statutory deadline of one year for a decision on the application.
“We believe that the Fed’s decisions are misguided and wrong,” said Caitlin Long, CEO and founder of Custodia Bank. “Despite these setbacks, Custodia remains committed to realizing our vision of a better kind of bank.”
Long said plans are still in place for Custodia to launch as a state-chartered bank while its lawsuit against the Fed Reserve continues and it appeals the Fed’s decisions.
The recent collapse of FTX, a cryptocurrency exchange and crypto hedge fund company, and other cases involving the mishandling of digital assets are exactly the reasons why Custodia’s application should be approved, she said.
“Recent turmoil within the digital asset sector, caused by fraudulent actors and lax oversight, has rightly spooked financial regulators,” Long said. “What’s lost amid the noise is that Custodia Bank’s non-leveraged, 100% liquid business model offers a solution to these risks. We are confident this reality will become clear to bank regulators in due time.”
Critics of the announcements out of Washington, D.C., say that if unchallenged, the actions will create more risk in the financial system, cost Wyoming millions of dollars in potential revenues and diminish its digital innovation efforts.
“The actions by the Fed are not about one particular applicant, but instead about whether digital assets should be regulated,” said U.S. Sen. Cynthia Lummis, R-Wyo. “As long as digital assets are left outside the regulatory perimeter, the risks to our financial system will grow, not abate.”
Lummis, who is a member of the U.S. Senate’s Banking Committee, said Fed Chair Jerome Powell has failed in his responsibility to ensure digital assets are properly regulated and the risks managed.
“The Fed has not given the applicant the required legal due process,” Lummis said of Custodia’s application for a master account. “There is no doubt in my mind that Wyoming’s SPDI laws fully comply with the Federal Reserve Act. The actions are obviously more about politics than bank regulation, and call into question whether the Fed is, in fact, free from political influence.”
The charter for Wyoming SPDIs was established by the Wyoming Legislature in 2019 to provide custodial services to holders of digital currencies, assets and securities. Former Republican legislator Tyler Lindholm of Sundance and current state Sen. Chris Rothfuss, D-Laramie, both served on the committee that drafted the bill creating the SPDIs. The rejection of Custodia’s master account application and the apparent repudiation of SPDIs disappoints and mystifies them in that they say the Federal Reserve Bank of Kansas City was consulted in every step of the legislation’s creation.
“Our big frustration, as it currently stands, is we know the importance of Federal Reserve access and what it means to be a bank,” Lindholm said. “We know that, because we’ve studied it, and we built the Special Purpose Depository Institution Charter around existing Wyoming law. We checked all of the boxes for the Federal Reserve Act. And then, on top of that, while we were drafting the legislation, we were consistently sending drafts of the legislation to the Kansas City Federal Reserve, and they had a couple of areas that they wanted us to vet that they weren’t really comfortable with.”
A specific piece of the proposed legislation concerned them, Lindholm said.
“One of those pieces was where we specifically said the attorney general for the state of Wyoming shall sue the Federal Reserve upon noncompliance by the Federal Reserve,” Lindholm said. “We knew they were going to pull some stuff like that, and that’s why we had the language in there. The Federal Reserve didn’t like it, for obvious reasons, so we pulled it out. It’s kind of a carrot approach. Fast forward to where we are now.”
Lindholm questions the politics behind the decision, as the Federal Reserve is supposed to be independent, but pointed out how its announcements concerning Custodia were released in conjunction with the White House blog on the need for more scrutiny of cryptocurrency activity.
“This is directly standing in front of (Wyoming’s) own economic development, economic development that we not only worked exceptionally hard on, but was well thought out and took a ton of input from the Federal Reserve,” Lindholm said. “We played by the rules. And now, all of a sudden, because we’re not major donors … or one of the big banks, I guess now we’re on the out. And that sucks.”
Rothfuss, who chairs the Legislature’s Select Committee on Blockchain, Financial Technology and Digital Innovation Technology, also rues the decision to remove language mandating the state sue the Fed if it failed to follow the Federal Reserve Act in dealing with SPDIs.
“This is exactly the kind of thing we were concerned about,” he said.
Rothfuss said he is “incredibly disappointed” in the Federal Reserve action.
“Honestly, it seems like the exact opposite of the way we would want to regulate digital assets as they relate to banking and the financial system,” Rothfuss said. “Where we provide clear guidance that embraces an emerging technology that is in widespread use and in high demand, they provide an outright rejection, as opposed to a constructive oversight. I’m just hopeful that we beat them down in the courts, because their judgment on this does not seem to be based on what’s in the best interest certainly of the state of Wyoming, but also for people that would like to confidently hold digital assets.”
The lack of communication from the Federal Reserve to Custodia isn’t too surprising to Julie Hill, a University of Alabama law professor who studies how it operates. Hill was a visiting professor at the University of Wyoming School of Law last fall.
“So, on what the Federal Reserve decision on Custodia might mean for other Wyoming SPDIs, or even other states that have been enacted SPDI-like legislative charters, it’s hard to know,” Hill said. “And part of the reason it’s hard to know is because the Federal Reserve is not particularly transparent about their master account policies or decisions.”
She called the Federal Reserve’s public announcement about Custodia a very rare move. Banks may be declined master account applications on a regular basis, but because of the lack of transparency by the Federal Reserve, the number of those decisions isn’t known, Hill said.
There is a possibility Custodia could reapply, as there is a recent case where a Colorado bank was denied a master account but was allowed to resubmit its application and was approved, she said.
“So, there must be some method or allowance for new business plans or changes to allow a new request for a master account,” Hill said. “Now, it would be nice if the Federal Reserve would tell us how that process comes about, but they certainly haven’t done it.”
