Bitcoin bank Custodia today sued the Federal Reserve Board of Governors and the Federal Reserve Bank of Kansas City charging they have “unlawfully” delayed for 19 months acting on its application for a master account with the Federal Reserve.
The bank, chartered in Wyoming under a crypto-friendly statute passed in 2019 allowing for “special purpose depository institutions,’’ says the master account would reduce its costs and is “vital” to its core mission of providing a bridge between digital assets and the U.S. dollar system.
According to the suit, the Federal Reserve has a legal obligation to act within a year and states on its own paperwork that it ordinarily takes just five to seven days to act on a master account application. Custodia’s suit alleges the Kansas City Fed’s processing of its application was moving along until the Spring of 2021, when the main Federal Reserve got involved. The suit seeks to force the Federal Reserve and the Kansas City branch to act on its application–and ultimately, to approve it.
Should Custodia win its suit or otherwise be granted a master account, it would be the first bitcoin bank to gain one. As Central Banks around the world seek to merge the best innovation that bitcoin and other blockchain-powered currencies offer, with the best of central management, the lawsuit–and the Fed’s reaction to it–could help define the very future of banking.
“Through this lawsuit, Custodia seeks to ensure that its Federal Reserve master account application receives the fair dealing and due process guaranteed to it by both federal statute and the U.S. Constitution,” said Custodia Bank’s spokesperson Nathan Miller in a statement. “Custodia has satisfied every rule applicable to it, and has gone beyond by applying to become a Fed member bank.”
Custodia Bank was founded by Morgan Stanley veteran Caitlin Long in 2020 under the name Avanti Financial Group. Unlike traditional banks that generate the lion’s share of their revenue from loans, Custodia was incorporated under Wyoming state regulations Long helped write that would require this new kind of bank to maintain custody of the cryptocurrency it holds. In March 2021 she raised a $37 million Series A from investors including Binance.US, Coinbase Ventures, Morgan Creek Digital, Slow Ventures, and Susquehanna, bringing the total raised to $44 million.
Long became a detractor of so-called rehypothecation, when banks lend money to others who lend that money to others in the aftermath of the Great Recession when a similar practice with subprime mortgages led to multiple claims of ownership over the same assets and obscured bad loans among bigger groups of loans. She was concerned similar behavior in crypto could undermine the value derived from bitcoin’s 21 million coins limit.
An early advocate of bitcoin Long became one of the first mainstream bankers to make blockchain her career in 2016 when she left her position as a managing director at Morgan Stanley to join New York-based Symbiont, an enterprise blockchain startup founded by fellow early adopters of bitcoin who wanted to capture the best of distributed ledger technology like blockchain, but in a way that respected privacy regulations and high volumes large enterprises served.
After helping onboard $7 trillion asset manager Vanguard among Symbiont’s first clients, Long branched out on her own to create financial products directly leveraging bitcoin. To fight the proliferation of rehypothecated bitcoin Long established Custodia to provide accounts for crypto businesses that would help them pay their employees and taxes, but would generate revenue by charging fees for services other than loans.
To do this her bank would need a master account with the Fed, like all federally chartered banks, that would in essence turn them into a direct line to the regulator. According to the statement, this was crucial to the bank’s business model as it would allow them to “sharply reduce its costs, and bring new products and options to users of financial services.”
“This delay in processing Custodia’s master account application is resulting in substantial, ongoing injury to Custodia,” according to the suit. “The immediate injury is that the delay has forced Custodia to defer its solo entry into the financial services market in favor of a decidedly second-best and far more expensive alternative: launching with a correspondent bank—which has a master account— while Custodia awaits a decision on its long-pending application.”
The filing further claims the Kansas City Fed received Custodia’s business plan in May 2020, and confirmed that Custodia’s master account application, submitted in late October 2020, was complete. In early 2021, a representative of the Kansas City Fed informed Custodia there were “no showstoppers” with the application, according to the filing.
Custodia’s 44-page suit lists eight claims for relief, or ways the Fed could potentially resolve the case. The first claim raises a broader issue regarding the functioning of the individual Federal Reserve banks and whether they are subject to rules for federal agencies, including the Administrative Procedure Act and requirements for due process. The suit says that if the Kansas City Federal Reserve is considered a private entity (its board is made up of a majority of private sector, non-presidentially appointed officials), it either can’t make final decisions on the issuing of master accounts without review by the Federal Reserve Board, or when it is exercising governmental powers, is subject to the higher level of scrutiny provided to governmental actors.
The Kansas City branch of the Federal Reserve declined to comment on the suit.
Initially slow to act on the innovations underlying bitcoin, which allow value to move without central authorities, the Federal Reserve has largely let other countries take the lead on incorporating the lessons learned. In 2020 China started public trials of its own Central Bank Digital Currency, and the Fed itself has expressed interest in letting the private sector innovate in the form of so-called stablecoins that are backed by assets like the U.S. dollar, but created by private companies. In 2020 Long revealed her own plans for what would amount to a stablecoin, but since she was planning on a Fed account it would be akin to a digital cashiers check, which could have resulted in a regulated digital dollar.
In May a stablecoin backed in part by bitcoin, a cryptocurrency called Luna, and stabilized using an algorithm that controlled supply, called TerraUSD, collapsed, erasing $60 billion worth of value, and leading to calls for more regulation of the space. Bipartisan regulation proposed this morning by U.S. Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) would in part see to concerns in the suit if implemented. Among a number of sweeping requirements, the Responsible Financial Innovation Act would require that the Fed issue routing numbers to depository institutions, prohibits Federal banking agencies from delaying applications under existing law and requires that they decide on all applications within a year.
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