Custodia Says Fed Attempt to 'Crush' Crypto Bank Was Political

Wyoming-based Custodia Bank argued Wednesday that the Federal Reserve Board has made misrepresentations about Custodia’s crypto-friendly business model to prevent the state-chartered bank from accessing payment and settlement systems.

In a 39-page brief, Custodia argued that winning its appeals case would not allow any depository institution to tap the Fed’s systems, nor would it prevent the Fed from being able to mitigate risks that are supposedly associated with banking crypto companies.

Earlier this month, 11 Federal Reserve banks that make up the Fed’s operating arm, in addition to the Kansas City Fed, argued that a “dangerous” precedent would be set if Custodia won its appeal. It would effectively strip the regional banks of their ability to mitigate risks to the financial system and themselves, the banks argued in a brief.

Custodia filed an appeal after losing its case in April, which argued that the bank is entitled to a so-called master account at the Fed. That status would allow Custodia to access the Fed’s liquidity facilities, as well as payment services like FedNow, reducing Custodia’s need to do relatively costly business with intermediary banks.

Custodia’s lawsuit, originally filed against the Federal Reserve Board in 2022, was amended last year following the rejection of its application to become a member institution. In its brief, Custodia argued that rejection was a “politically-determined outcome” stemming from high-level efforts to isolate the digital assets industry.

“The political winds shifted, and the weight of the federal regulatory infrastructure was deployed to crush a small Wyoming bank,” Custodia said, adding that the Federal Reserve Board of Kansas City, which covers Wyoming, was initially supportive.

The Federal Reserve Board of Kansas City “changed its tune” in several instances, Custodia argued. A description of Custodia’s risk management flipped from “strong” to “insufficient,” the bank said, citing other examples of how assessments changed.

Additionally, Custodia said its business was characterized as “totally unregulated” by the Federal Reserve Board. Arguing the notion is false, Custodia pointed to its regulation under the Wyoming Division of Banking and a “multi-year, safe operating history.”

While Custodia’s lawsuit hinges on the U.S. Court of Appeals for the 10th Circuit’s interpretation of banking laws including the Monetary Control Act, Custodia’s brief underscores industry headwind comparisons to Operation Choke Point.

The Obama-era initiative was targeted at banks that did business with porn makers, payday lenders, and gun manufacturers. Amid regulators’ shutdown of the crypto-friendly Signature Bank last year, the term “Operation Choke Point 2.0” emerged.

On her blog, Custodia founder and CEO Caitlin Long previously warned against the “politicization of banking,” arguing that the Fed’s vetoing of state-chartered banks’ access to payment systems represents a historic shift.

In its September brief, the Fed banks argued that the ability to reject master accounts is a “fundamental and universal risk-management tool.” Their ability to assess whether banks processed illicit transitions or have poor risk management controls would be hamstrung if Custodia won, they argued.

“These risks are not merely theoretical, and they are not specific to the crypto industry,” the banks said, citing other depository institutions denied master accounts.

As a state-chartered bank, Custodia is regulated under Wyoming law and supervised by a local regulator. And Custodia argued that the Fed’s description of its business model flies in the face of the balance of power between the federal and state governments.

“That appellees ignore state banking laws lays bare their anti-state bias,” Custodia said. “Far from attempting to avoid federal supervision, Custodia sought federal oversight by applying for FDIC insurance and applying to become a member bank.”

With its arguments fully articulated in writing, Custodia’s filing represents a milestone in its years-long quest for a master account. But before a decision in the appeals case is reached, both sides will have the chance to present oral arguments at court in the coming months.

Edited by Andrew Hayward