Wyoming Effort to Support Crypto-Focused Banks Set Back by Fed Concerns About Industry
In early 2019, Wyoming enacted legislation authorizing the creation of state-chartered banks catering to firms doing business with bitcoin and other cryptocurrencies.
The banks would serve as custodians of digital assets and take dollar deposits, forming a bridge between cryptocurrency and dollars for firms to make payroll and payments, or help realize crypto investment gains or losses.
Four years later, the Cowboy State’s experiment with state-chartered crypto banking has gone slower than expected. And it isn’t just because of last year’s cryptocurrency market crash and the collapse of crypto lenders and platforms.
The Federal Reserve hasn’t approved any of Wyoming’s four new special-purpose depository institutions, or SPDIs, that have filed applications for so-called master accounts that would give them access to the Fed’s financial payment systems that handle $4 trillion a day, according to state and private banking officials.
The Federal Reserve System’s board of governors sets guidelines for master accounts. The 12 regional Fed banks make the decisions on the applications. The Kansas City Fed has oversight of Wyoming banks. Officials at the Kansas City Fed declined to comment.
About 9,300 banks and credit unions have Fed master accounts, which industry officials refer to as bank accounts for banks. They are considered a lifeblood for the SPDI, or “speedy,” startups.
Wyoming officials say that state-chartered banks under law should have the same access to master accounts as federally chartered banks. They also insist that the SPDIs are safe because they can’t lend, and state law restricts them in other ways. But the Fed says it has discretion in approving master accounts and warns about risks that cryptocurrencies present to the financial system.
“I don’t think we are defeated by any stretch of the imagination,” said Democratic state Sen. Chris Rothfuss, a sponsor of the SPDI legislation, regarding the lack of Fed approval.
The fate of the master account at Custodia Bank in Cheyenne, Wyo., a SPDI which has raised $52 million, now is likely to be decided in a federal trial.
In June 2022, Custodia sued the Fed’s board of governors and the Kansas City Fed for an initial delay in obtaining a master account. Custodia amended the suit after the Kansas City Fed told it in late January that its application for a master account had been denied.
Custodia is authorized to take U.S. dollar deposits and provide custody services for bitcoin or ethereum owners, said Caitlin Long, the bank’s chief executive and a former managing director at Morgan Stanley. Custodia doesn’t act as an exchange to convert the digital assets under its care into fiat money—or dollars, she said. Custodia is looking to integrate its platform with exchanges that can provide exchange services, Long said.
This is similar to how a custodian of stocks in a mutual fund doesn’t own the stocks and isn’t a stock exchange itself but links up with one like the New York Stock Exchange for trading services.
“I am not defending the industry as a whole,” Long said of the cryptocurrency industry, which has been beset by investigations and criminal indictments. “The nuance is that there is some real technology at the core of it that is not just a tool for criminals and grifters.”
In its motion to dismiss the case in the Wyoming federal court, the Fed argued that “Custodia makes its claim of absolute entitlement even as the cryptocurrency industry on which it pins its entire business model suffers extreme volatility and loss, and the depository institutions with the closest ties to these activities have collapsed into liquidation or federal receivership.”
The cryptocurrency sector lost $2 trillion in market value by the fall of 2022 as Custodia was seeking its master account, the Fed said in the motion, claiming that Custodia lacked “appropriate risk management structures” and had a “novel and risky business model.”
This leaves Wyoming hanging for the moment, which frustrates Rothfuss.
Wyoming lawmakers consulted with the Kansas City Fed as they drafted the SPDI legislation and made changes based on the regional Fed bank’s suggestions, the Wyoming lawmaker said.
“The idea that a state needs to be held back because we were being innovative in a way that nationally chartered banks or the federal government had not caught up with is really a slap in the face of state rights,” Rothfuss said.
U.S. District Judge Scott W. Skavdahl in Wyoming has scheduled an April trial for the case.
Write to Bob Fernandez at bob.fernandez@wsj.com
