U.S. Federal Reserve rejects Crypto Bank's application for membership

In a rejection of a Wyoming crypto-centric bank's application to join the Fed's exclusive payment system, the Federal Reserve Board on Friday rejected the application.

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Federal Reserve officials said the firm's proposed business plan, as well as its focus on crypto assets, were significant safety and soundness concerns.

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There is no federal deposit insurance for the bank called Custodia. "Special purpose depository institution" describes the company.

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According to the Fed, the bank plans to issue crypto assets on decentralized networks.

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Custodia, which was previously known as Avanti, uses a special state license from Wyoming for banks that deal with cryptocurrencies. In 2022, Avanti sued the Kansas City Federal Reserve Bank for delaying a decision to grant it special access to the Fed, known as a master account.

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According to a statement from Caitlin Long, chief executive officer of Custodia, "Custodia is surprised and disappointed by the Board's decision today." 

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It is unfortunate that the Board denied Custodia's application, but this is consistent with the concerns Custodia has raised about the Federal Reserve's handling of its applications, which we will continue to pursue.

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As evidenced by the significant volatility in the crypto industry in the past year, the Fed recently stated that crypto activities contradict safe and sound banking practices.

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“We are not surprised by the decision. In our opinion, the Fed wants to prevent states from chartered entities supporting crypto from accessing payment systems or Fed liquidity programs,” Jaret Seiberg said to Trade Algo.

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We believe this explains why Custodia was denied membership in the state-member bank system and why the state issued the broader policy statement. Custodia will not receive a Master Account from the Fed," he explained.

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Firms can access Fed-related payment systems through a master account. State-chartered crypto firms have applied for master accounts to facilitate seamless transitions between crypto and official currency, according to Congressional Research Service, an organization within the Library of Congress that conducts public policy research.

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“Once you get a master account then you have access to Fed facilities and two things happen,” Dennis Kelleher explained to Trade Algo. Getting external validation from the Fed for your financial activities is a legitimizing activity, and many more people will do business with you as a result." 

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A second problem, said Kelleher, is that when you get interconnected with the Fed, the central bank will have an interest in making sure a firm doesn't fail because of the collateral consequences.

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A separate but related Fed statement released on Friday aimed at ensuring all banks with a federal supervisor play on the same level, regardless of whether or not they receive deposit insurance.

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In the event that a bank fails, the Federal Deposit Insurance Corporation provides insurance to protect bank accounts. On Friday, the Fed indicated the Board would limit the activities of insured and uninsured banks.

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In their applications, banks must demonstrate that the activities they engage in are permitted by law, and have internal controls, risk management processes, and other measures in place that are “appropriate and adequate” for the nature, scope, and risk of their activities.

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“By gaining access to and incorporation into the banking system, the crypto industry and its political allies can make incredibly lucrative profits,” stated Kelleher, adding that taxpayers would benefit from such a move. Crypto industry members will be disappointed with Custodia's failure, he said.