{"id":25240,"date":"2023-04-09T17:09:33","date_gmt":"2023-04-09T17:09:33","guid":{"rendered":"https:\/\/davidgerard.co.uk\/blockchain\/?p=25240"},"modified":"2023-04-09T19:07:39","modified_gmt":"2023-04-09T19:07:39","slug":"so-much-for-wyoming-blockchain-regulatory-capture-the-fed-blocks-custodia-bank","status":"publish","type":"post","link":"https:\/\/davidgerard.co.uk\/blockchain\/2023\/04\/09\/so-much-for-wyoming-blockchain-regulatory-capture-the-fed-blocks-custodia-bank\/","title":{"rendered":"So much for Wyoming blockchain regulatory capture \u2014 the Fed blocks Custodia Bank"},"content":{"rendered":"<p><em>By <strong>Amy Castor<\/strong> and <strong>David Gerard<\/strong><\/em><\/p>\n<ul>\n<li aria-level=\"1\">Writing this good stuff takes time, and time is money. <a href=\"https:\/\/www.patreon.com\/amycastor\">Send Amy money here<\/a> and <a href=\"https:\/\/www.patreon.com\/davidgerard\">David here.<\/a> <em>One weird trick<\/em> that crypto doesn\u2019t want you to know!<\/li>\n<\/ul>\n<p>Caitlin Long had high hopes of bringing crypto into the mainstream financial system. Long\u2019s Custodia Bank in Cheyenne, Wyoming, a state-charted special purpose depository institution, or SPDI, was spearheading those dreams for all of cryptocurrency.<\/p>\n<p>Those dreams, and the clown car they rode in on, crashed into the concrete bollard of reality on January 27, 2023, when the Federal Reserve Board denied Custodia\u2019s application to be a Federal Reserve member bank, and the Federal Reserve Bank of Kansas City denied its application for a master account. [<a href=\"https:\/\/www.federalreserve.gov\/newsevents\/pressreleases\/orders20230127a.htm\"><i>Press release<\/i><\/a><i>; <\/i><a href=\"https:\/\/www.americanbanker.com\/news\/kansas-city-fed-rejects-custodias-master-account-application\"><i>American Banker<\/i><\/a><i>, <\/i><a href=\"https:\/\/archive.is\/CJEAf\"><i>archive<\/i><\/a>]<\/p>\n<p>The Board\u2019s full 86-page order, made public on March 25, details how Custodia failed to address \u201cthe heightened risks associated with crypto activities, including its ability to mitigate money laundering and terrorism financing risks.\u201d (The Kansas City Fed\u2019s denial letter was not made public.) [<a href=\"https:\/\/www.federalreserve.gov\/newsevents\/pressreleases\/files\/orders20230324a1.pdf\"><i>Order<\/i><\/a><i>, PDF<\/i>]<\/p>\n<p>The Board\u2019s order phrases it in bureaucratic euphemisms \u2014 but they understood extremely well that this was a gang of inept grifters. The fundamental issue is that Custodia have no idea what they\u2019re doing. The order notes repeatedly that:<\/p>\n<blockquote><p>considerations relating to the managerial factor are so adverse as to present sufficient grounds on their own for warranting denial of the application.<\/p><\/blockquote>\n<p>&nbsp;<\/p>\n<p><a href=\"https:\/\/davidgerard.co.uk\/blockchain\/2023\/04\/09\/so-much-for-wyoming-blockchain-regulatory-capture-the-fed-blocks-custodia-bank\/clown-car-on-fire\/\" rel=\"attachment wp-att-25242\"><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-full wp-image-25242\" src=\"https:\/\/davidgerard.co.uk\/blockchain\/wp-content\/uploads\/2023\/04\/clown-car-on-fire.jpg\" alt=\"\" width=\"510\" height=\"315\" srcset=\"https:\/\/davidgerard.co.uk\/blockchain\/wp-content\/uploads\/2023\/04\/clown-car-on-fire.jpg 680w, https:\/\/davidgerard.co.uk\/blockchain\/wp-content\/uploads\/2023\/04\/clown-car-on-fire-300x185.jpg 300w, https:\/\/davidgerard.co.uk\/blockchain\/wp-content\/uploads\/2023\/04\/clown-car-on-fire-348x215.jpg 348w\" sizes=\"auto, (max-width: 510px) 100vw, 510px\" \/><\/a><\/p>\n<p>&nbsp;<\/p>\n<h3>The elusive Fed master account<\/h3>\n<p>If you want access to the Fed\u2019s payment rails, including Fedwire, to settle transactions with other member banks in central bank money, you need your own account at one of the twelve Federal Reserve Banks.<\/p>\n<p>A master account would be cheaper and much more convenient for Custodia, because they wouldn\u2019t have to go through an intermediary bank.<\/p>\n<p>Custodia applied for a master account with the Federal Reserve Bank of Kansas City, which covers Wyoming, on October 29, 2020. Separately, it applied to become a member of the Federal Reserve on August 5, 2021. State-chartered banks aren\u2019t required to become Federal Reserve member banks \u2014 but if you want a master account, it really helps to become a member. [<a href=\"https:\/\/custodiabank.com\/press\/avanti-statement-on-its-application-to-become-a-federal-reserve-member-bank\/\"><i>Custodia press release<\/i><\/a>]<\/p>\n<p>The local Federal Reserve banks (private banks, highly regulated) make decisions on granting master accounts \u2014 but it\u2019s the Federal Reserve itself (part of the US government) that sets the rules.<\/p>\n<p>The job of the Federal Reserve is to make sure that member banks don\u2019t introduce risks to the US financial system or facilitate illicit activities.<\/p>\n<p>You don&#8217;t get Fed membership just by saying your state calls you a \u201cbank.\u201d The Board evaluated Custodia\u2019s application on four factors:<\/p>\n<ul>\n<li aria-level=\"1\">Management: is the management competent?<\/li>\n<li aria-level=\"1\">Financial: Does the bank&#8217;s funding model make sense?<\/li>\n<li aria-level=\"1\">Corporate powers: Is the bank&#8217;s business consistent with the purposes of a Federal Reserve account?<\/li>\n<li aria-level=\"1\">Convenience and needs: does the bank serve its community?<\/li>\n<\/ul>\n<p>Traditional banks generally get approved for a master account within days. But Custodia was doing novel things. It wanted to specialize in crypto, an industry rife with fraud; it wanted to issue its own dollar substitute \u2014 a stablecoin called Avit; and it had no FDIC insurance. Custodia wanted to be a <a href=\"https:\/\/davidgerard.co.uk\/blockchain\/2021\/01\/21\/stablecoins-through-history-michigan-bank-commissioners-report-1839\/\">wildcat bank<\/a> with central bank money.<\/p>\n<p>As a result, it took more than two years for Custodia to get a response on its account application.<\/p>\n<p>Prior to the Fed releasing its final guidelines, Custodia filed a suit in the Federal Court of Wyoming against the Federal Reserve Board and the Federal Reserve Bank of Kansas City in June 2022, alleging a \u201cpatently unlawful delay.\u201d [<a href=\"https:\/\/www.documentcloud.org\/documents\/22054891-custodia-federal-reserve\"><i>complaint<\/i><\/a><i>, PDF; <\/i><a href=\"https:\/\/www.courtlistener.com\/docket\/63366375\/custodia-bank-inc-v-federal-reserve-board-of-governors\/\"><i>case docket<\/i><\/a>]<\/p>\n<p>Custodia believes that the Fed is <i>required<\/i> to give a master account to any state bank that asks. Both the Kansas City Fed and the Board argue that the law really doesn\u2019t say that, and the Fed has frequently exercised its discretion not to grant membership or accounts automatically. Custodia also believes there\u2019s a conspiracy to exclude it, and crypto in general, from the financial system. The lawsuit is still ongoing.<\/p>\n<p>The Fed had serious concerns about crypto getting mixed up with central bank money \u2014 and master accounts were becoming a contentious issue. The local Feds were increasingly getting applications for master accounts from fintechs and non-traditional banks.<\/p>\n<p>So the Fed proposed a new master account guideline in May 2021 and released the final guideline on August 22, 2022 \u2014 to make it clear that \u201cinstitutions that engage in novel activities and for which authorities are still developing appropriate supervisory and regulatory frameworks would undergo a more extensive review.\u201d<\/p>\n<p>The guidelines list three tiers. Tier 3, which Custodia fell into, would require the most scrutiny. [<a href=\"https:\/\/www.federalreserve.gov\/newsevents\/pressreleases\/other20220815a.htm?\"><i>Press release<\/i><\/a><i>; <\/i><a href=\"https:\/\/www.federalreserve.gov\/newsevents\/pressreleases\/files\/other20220815a1.pdf\"><i>Guidelines<\/i><\/a><i>, PDF<\/i>]<\/p>\n<p>On January 3, 2023, the Federal Reserve issued a joint statement with the OCC and the FDIC about crypto: \u201c\u200b\u200bIt is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system.\u201d And on January 27, the same day that Custodia received its rejections, the White House released its \u201croadmap\u201d to mitigating cryptocurrency risk, which directs regulatory agencies to \u201cramp up enforcement.\u201d [<a href=\"https:\/\/www.fdic.gov\/news\/press-releases\/2023\/pr23002a.pdf\"><i>FDIC<\/i><\/a>; <a href=\"https:\/\/archive.is\/o\/CJEAf\/whitehouse.gov\/nec\/briefing-room\/2023\/01\/27\/the-administrations-roadmap-to-mitigate-cryptocurrencies-risks\/\"><i>Whitehouse<\/i><\/a>]<\/p>\n<p>If you want to get your bank into crypto, you have to satisfy the Fed that you understand the risks. Custodia doesn\u2019t seem to have understood the question.<\/p>\n<h3>The grand dream<\/h3>\n<p>Bitcoin was created by extreme libertarians who resented financial regulation as a moral offense against free individuals. Their economic ideas were based in <a href=\"https:\/\/davidgerard.co.uk\/blockchain\/the-conspiracist-gold-bug-economics-of-bitcoin\/\">conspiracy theories.<\/a><\/p>\n<p>Even when the crypto world tries to work with the world of actual money, they still have this attitude \u2014 they fundamentally don\u2019t understand how anything works, and resent the idea that any of the rules should apply to them.<\/p>\n<p>But they still want the government to save them when it all goes south.<\/p>\n<p>Long, a Wyoming native, came up with <i>one weird trick<\/i> to let crypto work around a whole swathe of regulations \u2014 the regulatory capture of the least populous state in the US, that already leaned libertarian. This would definitely work!<\/p>\n<p>In November 2017, Long launched the Wyoming Blockchain Coalition. The 2017 bitcoin bubble was in full swing. The group\u2019s stated goal was to promote crypto as a business opportunity for Wyoming. [<a href=\"https:\/\/www.coindesk.com\/markets\/2017\/11\/15\/blockchain-advocacy-group-launched-in-wyoming\/\"><i>CoinDesk<\/i><\/a><i>, 2017<\/i>]<\/p>\n<p>The Coalition\u2019s actual program was:<\/p>\n<ul>\n<li aria-level=\"1\">Create a new Wyoming state bank charter for crypto;<\/li>\n<li aria-level=\"1\">Launch a \u201cbank\u201d using this form of charter;<\/li>\n<li aria-level=\"1\">Gain access to New York customers\u2019 money without having to go through the rigmarole of applying for a New York BitLicense;<\/li>\n<li aria-level=\"1\">Obtain a Federal Reserve master account, which would thus back deposits of crypto with US government dollars.<\/li>\n<\/ul>\n<p>The Coalition promoted legislation to this effect through 2018. In February 2019, Wyoming created\u00a0 SPDIs, a variant on trust companies, so that crypto companies could easily get a \u201cbank.\u201d These institutions would hold full reserves and not have FDIC deposit insurance. The structure is that of a state trust company. [<a href=\"https:\/\/www.coindesk.com\/markets\/2019\/02\/20\/wyoming-lawmakers-pass-three-bills-in-boost-for-states-crypto-industry\/\"><i>CoinDesk<\/i><\/a><i>, 2019; <\/i><a href=\"https:\/\/wyofile.com\/blockchain-can-wyo-court-a-digital-revolution-should-it\/\"><i>WyoFile<\/i><\/a><i>, 2019<\/i>; <a href=\"https:\/\/wyomingbankingdivision.wyo.gov\/banks-and-trust-companies\/special-purpose-depository-institutions\"><i>Wyoming Division of Banking<\/i><\/a>]<\/p>\n<p>SPDIs are only sort-of banks. They\u2019re not allowed to lend dollars. Under the Bank Holding Company Act, to qualify as a bank, a firm has to <i>make loans<\/i>. [<a href=\"https:\/\/www.federalreservehistory.org\/essays\/bank-holding-company-act-of-1956#:~:text=For%20the%20purposes%20of%20the,had%20to%20be%20fixed%20later.\"><i>Federal Reserve History<\/i><\/a>]<\/p>\n<p>Custodia planned to pay zero interest on deposits \u2014 and charge users for transactions.<\/p>\n<p>Lending money is the main way that banks make a profit. The lending that Custodia planned to do was in unregulated crypto assets \u2014 while exposing the central bank deposits to risk.<\/p>\n<p>The crypto world hoped that a state charter for an SPDI would be a trump card that would let them work around all that tedious banking regulation, and all the problems that crypto companies had with getting banking at all. [<a href=\"https:\/\/www.coindesk.com\/business\/2020\/01\/14\/what-it-takes-to-get-a-crypto-friendly-bank-charter-in-wyoming\/\"><i>CoinDesk<\/i><\/a><i>, 2020<\/i>]<\/p>\n<p>Or as the American Banker\u2019s Association put its concerns: [<a href=\"https:\/\/www.aba.com\/-\/media\/documents\/advocacy\/state-laws\/special-purpose-depository-institution-spdi-legislation.pdf?rev=d31c62c1df5745bfbbbad50309f93ecc&amp;hash=DD9E2E93A5954434EACD32BEA1F0F041\"><i>ABA<\/i><\/a><i>, PDF<\/i>]<\/p>\n<blockquote><p>The ultimate goal of the new charter is to gain direct access to the Federal Reserve and the US payments system without being subject to the same regulatory and supervisory framework with which banks must comply. Indeed the business model behind the charter is to intentionally sidestep this important framework.<\/p><\/blockquote>\n<p>At CoinDesk Invest: NYC in November 2019, the Wyoming crew \u2014 both the blockchain promoters and their pet regulators \u2014 talked up their goal to just waltz around New York\u2019s \u201conerous\u201d BitLicense. [<a href=\"https:\/\/www.coindesk.com\/markets\/2019\/11\/14\/wyomings-new-crypto-banking-law-could-defang-new-yorks-bitlicense\/\"><i>CoinDesk<\/i><\/a><i>, 2019<\/i>]<\/p>\n<p>The theory was that because New York exempts national banks from the requirement to obtain a BitLicense to operate, Wyoming\u2019s SPDIs \u2014 which are state-chartered \u2014\u00a0 should also be exempted.<\/p>\n<p>This is an untested idea. New York-based trust companies are automatically exempt from the BitLicense, but it\u2019s not clear if out-of-state ones are.<\/p>\n<p>The Kraken crypto exchange and Charles Hoskinson\u2019s IOHK, the company behind the Cardano cryptocurrency, were also involved in putting together the legislation. [<a href=\"https:\/\/wyofile.com\/links-drive-allegation-of-insiders-writing-crypto-bills\/\"><i>WyoFile<\/i><\/a><i>, 2019<\/i>]<\/p>\n<p>Wyoming passed other laws to encourage the use of crypto \u2014 sports betting using crypto, a law to incorporate your DAO as an LLC, and Long even tried to sell an obsolete coal power plant to bitcoin miners. [<a href=\"https:\/\/wyofile.com\/old-plants-new-ideas-who-might-buy-a-retired-coal-power-unit\/\"><i>WyoFile<\/i><\/a><i>, 2019; <\/i><a href=\"https:\/\/www.coindesk.com\/policy\/2021\/04\/07\/wyomings-new-online-sports-betting-law-oks-crypto-wagers\/\"><i>CoinDesk<\/i><\/a><i>, 2021; <\/i><a href=\"https:\/\/www.coindesk.com\/policy\/2021\/04\/22\/state-lawmaker-explains-wyomings-newly-passed-dao-llc-law\/\"><i>CoinDesk<\/i><\/a><i>, 2021<\/i>]<\/p>\n<p>Wyoming locals weren\u2019t happy with crypto industry people coming to town and writing laws to benefit only themselves. Wyoming entrepreneur David Dodson wrote: \u201cBy allowing the laws to be shaped and written by those who benefit from them, our legislative hard work accomplished everything the blockchain industry wanted but nothing the state needs. Namely, jobs and revenue.\u201d [<a href=\"https:\/\/www.wyofile.com\/wyomings-crypto-blockchain-giveaway\/\"><i>WyoFile<\/i><\/a><i>, 2020<\/i>]<\/p>\n<p>Kraken Bank was the first to get an SPDI charter in September 2020. Custodia (which called itself Avanti until early 2022) followed in October 2020, then Wyoming Deposit &amp; Transfer in June 2021, and Commercium Financial in August 2021. [<a href=\"https:\/\/www.coindesk.com\/business\/2020\/09\/16\/kraken-becomes-first-crypto-exchange-to-charter-a-us-bank\/\"><i>CoinDesk<\/i><\/a><i>, 2020; <\/i><a href=\"https:\/\/www.coindesk.com\/markets\/2021\/06\/22\/wyoming-deposit-transfer-gets-charter-to-provide-crypto-custodial-services\/\"><i>CoinDesk<\/i><\/a><i>, 2021; <\/i><a href=\"https:\/\/www.coindesk.com\/business\/2021\/08\/11\/commercium-financial-becomes-fourth-wyoming-chartered-crypto-bank\/\"><i>CoinDesk<\/i><\/a><i>, 2021<\/i>]<\/p>\n<p>Custodia promptly waved its shiny new SPDI charter at the Kansas City Fed and asked for a master account. This would allow a world of crypto innovation \u2014 backed by the Fed!<\/p>\n<p>Custodia has so far received $45.5 million in venture funding to support its efforts. It has no other income as yet. [<a href=\"https:\/\/www.crunchbase.com\/organization\/avanti-financial-group\"><i>Crunchbase<\/i><\/a>]<\/p>\n<h3>Custodia\u2019s business plan<\/h3>\n<p>Custodia planned to offer services online in all 50 states, and later internationally:<\/p>\n<ul>\n<li aria-level=\"1\"><b>Core banking<\/b>: Deposit accounts for crypto businesses and the wealthy \u2014 ACH, wire transfers, and so on. Cash deposits could only come from corporate customers in amounts of not less than $5,000. Custodia could not lend dollars.<\/li>\n<li aria-level=\"1\"><b>Custody services:<\/b> Crypto would be held in a separate trust to ensure separation from customer deposits. Custodia calls this bank charter a \u201cbridge\u201d between crypto and dollar markets. Customers could use crypto to make direct payments, invest, and so on without having to convert their tokens into fiat.<\/li>\n<li aria-level=\"1\"><b>Prime services:<\/b> Buy, sell, borrow, and lend crypto assets \u2014 crypto exchange services, with Custodia making its money on fees.<\/li>\n<li aria-level=\"1\"><b>Avit:<\/b> A dollar stablecoin, running on Ethereum and Liquid.<\/li>\n<\/ul>\n<p>Those first three add up to a crypto exchange whose US dollar banker is the Fed, with an attached US dollar bank for crypto businesses. The fourth proposes a stablecoin whose reserve is kept at the Fed.<\/p>\n<p>The Fed said that it couldn\u2019t let Custodia get into the last three businesses at all, and that Custodia lacked a sufficient business plan to do even just core banking sustainably \u2014 nor did it have the managerial competence to start an unusual new banking business safely.<\/p>\n<h3>A crypto exchange by any other name<\/h3>\n<p>Running a bank is a well-understood business, right? But first, you need competent bankers who understand the regulatory requirements and aren\u2019t clowns. Per the Fed:<\/p>\n<blockquote><p>The findings of Federal Reserve staff\u2019s pre-membership examination suggested significant deficiencies in Custodia\u2019s ability to manage the risks of its day-one activities, which consist of limited basic banking services.<\/p>\n<p>Specifically, the findings indicated Custodia\u2019s risk management and controls for its core banking activities were insufficient, particularly with respect to overall risk management; compliance with the Bank Secrecy Act (\u201cBSA\u201d) and U.S. sanctions; information technology (\u201cIT\u201d); internal audit; financial projections; and liquidity risk management practices.<\/p><\/blockquote>\n<p>Custodia\u2019s core banking business was projected to be a relatively small part of its overall business. The real business was the stablecoin and the crypto exchange \u2014 but core banking had no real income stream without those.<\/p>\n<p>Custodia wanted to do novel \u2014 indeed, \u201cunprecedented\u201d \u2014 things. Allowing innovation to prosper requires understanding the risks. The Board saw no sign that Custodia understood the risks.<\/p>\n<p>The lack of effective anti-money laundering seems to have been the main issue. AML is not a nice extra you can bolt on later. The Fed requires that you have your AML in place already.<\/p>\n<p>Custodia planned to offer custody services for bitcoin and ether. The sticking point for the Board on this one was Custodia\u2019s plan to keep crypto on its books \u201cto pay customers\u2019 transaction fees\u201d:<\/p>\n<blockquote><p>The Board has not identified any authority to support the position that national banks are permitted to hold bitcoin, ether, or most other crypto-assets as principal in any amount or for any purpose &#8230; state banks have not been expressly permitted to do so by federal statute or part 362 of the FDIC\u2019s regulations.<\/p><\/blockquote>\n<p>\u201cPrime services\u201d would allow customers to buy and sell cryptos via Custodia, who would get orders from other exchanges as the back end.<\/p>\n<p>Custodia would also let customers borrow and lend cryptos that were held in trust accounts.<\/p>\n<h3>Avit \u2014 wildcat banking, but on the blockchain<\/h3>\n<p>Avit was the big one. Avit was Custodia\u2019s plan to issue its own dollar stablecoin on Ethereum and Liquid \u2014 with the backing reserve stored at the Fed!<\/p>\n<p>The Board compared Avit to Tether and USDC. Users who weren\u2019t even customers of Custodia could hold, redeem or transfer Avits between themselves. Avit tokens would be <a href=\"https:\/\/davidgerard.co.uk\/blockchain\/2021\/01\/21\/stablecoins-through-history-michigan-bank-commissioners-report-1839\/\">wildcat banknotes<\/a> \u2014 private dollar bills, flowing about freely outside any possible control by Custodia.<\/p>\n<p>Custodia told the Fed that Avits would not be stablecoins, but \u201ca new payment technology.\u201d Nevertheless, the Board assessed Avit as a \u201cstablecoin.\u201d OCC Interpretive Letters 1174 and 1179 specifically permit a national bank to issue \u201cstablecoins\u201d for payments. [<a href=\"https:\/\/www.occ.gov\/news-issuances\/news-releases\/2021\/nr-occ-2021-2a.pdf\"><i>Letter 1174<\/i><\/a><i>, PDF; <\/i><a href=\"https:\/\/www.occ.gov\/topics\/charters-and-licensing\/interpretations-and-actions\/2021\/int1179.pdf\"><i>Letter 1179<\/i><\/a><i>, PDF<\/i>]<\/p>\n<p>The Board had \u201cbroader concerns\u201d \u2014 a term that means \u201cyou fail\u201d, much as \u201cuncertain\u201d means \u201cyou fail\u201d \u2014 about a stablecoin that could be held by persons unknown to the issuer, or that ran on a decentralized network where the issuer had no control over the validators handling its token.<\/p>\n<p>OCC Interpretive Letter 1174 specifically requires a stablecoin to be able to \u201cobtain and verify the identity of all transacting parties, including for those using unhosted wallets.\u201d That would include third-party users of your token on Ethereum, for example. Custodia could freeze or blacklist Avits after the fact, but the Board didn\u2019t consider that sufficient.<\/p>\n<p>As an Ethereum ERC-20 token, Avit would be tradeable outside the control of Custodia, and usable as a dollar in DeFi trading.<\/p>\n<p>The Board was not happy that Avit would rely on unknown and unknowable validators, who might affect Avit holders in ways Custodia couldn\u2019t easily remedy.<\/p>\n<p>The Board\u2019s biggest worry was the risk of bank runs on Avit \u2014 users rushing to cash out in bad times. All transactions would be visible on a blockchain \u2014 so anyone could see a bank run happening live.<\/p>\n<p>Avit would be 100% backed, but that\u2019s not enough \u2014 because bank runs are notoriously contagious. The Fed notes: \u201cRuns on any bank or financial intermediary have been documented to lead to panic and contagion that spreads to other banks and financial intermediaries.\u201d A bank run <i>anywhere<\/i> in the Federal Reserve system would spur wider panic.<\/p>\n<p>Precisely such a series of contagious bank runs \u2014 <a href=\"https:\/\/amycastor.com\/2023\/03\/09\/crypto-collapse-good-night-silvergate-bank-unbanking-crypto-exchanges-voyager-sale-to-binance-proceeding\/\">Silvergate<\/a>, then <a href=\"https:\/\/davidgerard.co.uk\/blockchain\/2023\/03\/12\/crypto-collapse-silicon-valley-bank-falls-and-takes-out-usdc-new-york-calls-eth-a-security\/\">Silicon Valley Bank<\/a>, then <a href=\"https:\/\/amycastor.com\/2023\/03\/14\/crypto-collapse-signature-bank-blows-up-us-crypto-frantically-looks-for-banking\/\">Signature<\/a> \u2014 happened just weeks after Custodia\u2019s applications were rejected.<\/p>\n<p>Avit would be backed by dollars on the Federal Reserve\u2019s balance sheet. That\u2019s a feature for prospective Avit users \u2014 but not for the Fed. If Avit became popular, it \u201ccould generate particularly pronounced demand for Federal Reserve liabilities.\u201d<\/p>\n<p>The Avit would be sufficiently close to a Federal Reserve Bank dollar that it could \u201cplausibly become a tool for persons around the world to access the stability of the U.S. dollar instantly and anonymously\u201d \u2014 that is, to launder money at scale.<\/p>\n<p>Custodia\u2019s plan explicitly stated that there would be Avit users who were not known to them. Custodia thought that this unknowability would absolve them of BSA\/OFAC responsibility for non-customer movements of Avit, and that they wouldn\u2019t be required to file suspicious activity reports (SARs).<\/p>\n<p>The Board was not buying this theory, and it was absolutely not going to enable a financial instrument that would set up a laundromat for US dollars.<\/p>\n<p>Nor was the Board happy that crypto is a disaster area, exposing ordinary Avit holders to all its risks:<\/p>\n<blockquote><p>they could be traded on largely unregulated or noncompliant exchanges; lent on crypto-lending platforms; and invested in decentralized finance protocols. Each of these poses risks to Avit holders, as demonstrated by the bankruptcies of FTX, Voyager, Celsius, Blockfi, and the collapse of the Terra\/Luna protocol.<\/p><\/blockquote>\n<p>These concerns strongly suggest that the Fed will <i>never<\/i> authorize a bank to issue a stablecoin on a public blockchain.<\/p>\n<h3>But what about the community?<\/h3>\n<p>Custodia doesn\u2019t have a local community to serve. Instead, it defined its \u201ccommunity\u201d as \u201cthe crypto-asset market.\u201d<\/p>\n<p>That\u2019s fine. But Custodia\u2019s business plan wasn\u2019t sustainable, its deposits wouldn\u2019t be backed, and its plan for resolution if it failed was to sell itself to other crypto companies \u2014 who would also be in trouble if crypto took a downturn. As we\u2019ve seen happening through 2022, when would-be rescuers promptly fail in turn.<\/p>\n<p>As such, Custodia would not be the savior of crypto \u2014 in fact, \u201cthe current record indicates Custodia could pose significant risk to its community.\u201d Whoops.<\/p>\n<h3>Competence is required<\/h3>\n<p>The board wants to see bank proposals from companies whose management has actual banking experience. Custodia has none of that, and Custodia\u2019s management team has very little understanding of how banks actually work:<\/p>\n<blockquote><p>The depth of banking experience and bank-specific risk management experience among the board of directors and management team is limited, and Custodia\u2019s board, executives, and staff come from a variety of backgrounds that are largely outside of traditional commercial banking, which is the context in which the pre-membership examination was conducted based on Custodia\u2019s proposed day-one activities.<\/p>\n<p>&#8230; The number and degree of shortcomings identified in the pre-membership examination suggest that management\u2019s experience is not commensurate with the firm\u2019s intended risk profile.<\/p><\/blockquote>\n<p>The Board notes \u201csignificant turnover in management\u201d at Custodia.<\/p>\n<p>These experience-free aspiring bankers were going to specialize in one limited sector of the economy, which also happened to be a disaster area:<\/p>\n<blockquote><p>In general, the Board has heightened concerns about banks with business plans focused on a narrow sector of the economy. Those concerns are further elevated with respect to Custodia because it is an uninsured depository institution seeking to focus almost exclusively on offering products and services related to the crypto-asset sector, which presents heightened illicit finance and safety and soundness risks.<\/p><\/blockquote>\n<p>With the Fed\/FDIC\/OCC statement on banks and crypto, and the recent string of bank failures, there\u2019s no way they\u2019re going to let bozos like Custodia loose on the actual economy where people live. The US government will not become your bagholder of last resort.<\/p>\n<h3>What happens next?<\/h3>\n<p>The Fed has denied Custodia\u2019s member application \u201cwithout prejudice,\u201d meaning they can apply again \u2014 but Custodia would be expected to show that they can address <i>all<\/i> of the Fed\u2019s objections. The trouble is that Custodia doesn\u2019t understand the questions.<\/p>\n<p>The Wyoming blockchain plan was always delusional. They thought they could use one weird trick to get around regulation \u2014 any kind of regulation. This was never going to work even before crypto screwed up as hard as it did all through 2022.<\/p>\n<p>Caitlin Long is still a crypto conspiracy theorist. As are the hosts on CoinDesk TV, because they know their viewers. That\u2019s great if you need to market yourself to crypto cranks \u2014 but it doesn\u2019t play so well in the world of real money. [<a href=\"https:\/\/www.youtube.com\/watch?v=Ay0a9cgNwBo&amp;t=36s\"><i>YouTube<\/i><\/a>]<\/p>\n<p>Custodia won\u2019t stop. They\u2019ll see this through to the bitter end \u2014 because there\u2019s nothing left to do except set the rest of their venture funders\u2019 money on fire. There are executives and lawyers to pay, after all.<\/p>\n<p>The Fed, the OCC, the FDIC, and the Treasury will be keeping an eye out in the future for attempts at regulatory capture of a small state by grifters trying to use it as a way into the real economy.<\/p>\n<br><br><div align=\"center\"><p><a href=\"https:\/\/www.patreon.com\/bePatron?u=8420236\"><img src=\"https:\/\/davidgerard.co.uk\/blockchain\/wp-content\/uploads\/2021\/10\/become_a_patron_button.svg\" alt=\"Become a Patron!\" title=\"Become a Patron!\" width=217 height=51><\/a><br><p style=\"align:center;\" class=\"patreon-badge\"><i>Your subscriptions keep this site going. <a href=\"https:\/\/www.patreon.com\/bePatron?u=8420236\">Sign up today!<\/a><\/i><\/p><\/div>","protected":false},"excerpt":{"rendered":"<p>Goodbye to Caitlin Long&#8217;s dreams \u2014 and the clown car they rode in on.<\/p>\n","protected":false},"author":1,"featured_media":25242,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false,"jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[1],"tags":[3488,3489,1993,940,1475,3440,1515,391,594,745,1556],"class_list":["post-25240","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-uncategorised","tag-avit","tag-bitlicense","tag-caitlin-long","tag-cardano","tag-charles-hoskinson","tag-custodia","tag-federal-reserve","tag-kraken","tag-new-york","tag-united-states","tag-wyoming"],"jetpack_featured_media_url":"https:\/\/davidgerard.co.uk\/blockchain\/wp-content\/uploads\/2023\/04\/clown-car-on-fire.jpg","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts\/25240","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/comments?post=25240"}],"version-history":[{"count":33,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts\/25240\/revisions"}],"predecessor-version":[{"id":25274,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts\/25240\/revisions\/25274"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/media\/25242"}],"wp:attachment":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/media?parent=25240"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/categories?post=25240"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/tags?post=25240"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}