Order denying Custodia Bank's application for Fed membership (decided 2023-01-27; published 2023-03-24)
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FRB Order No. 2023-02
January 27, 2023
FEDERAL RESERVE SYSTEM
Custodia Bank, Inc.
Cheyenne, Wyoming
Order Denying Application for Membership
Custodia Bank, Inc., Cheyenne, Wyoming (“Custodia”), a de novo, state-chartered
special purpose depository institution (“SPDI”), has requested the Board’s approval
under section 9 of the Federal Reserve Act (the “Act”) to become a member of the
Federal Reserve System. 1 Custodia intends to focus its business model almost entirely on
the crypto-asset 2 sector, and has described itself as seeking to become “a compliant
bridge” between the U.S. dollar payment system and the crypto-asset ecosystem. 3
Custodia proposes to provide a limited offering of core banking products and services
and to develop various crypto-asset products and services, including crypto-asset custody,
1
12 U.S.C. § 321 et seq.
2
Throughout this Order, the term “crypto-assets” refers to digital assets issued using
distributed ledger technology and cryptographic techniques (e.g., bitcoin and ether), but
does not include such assets to the extent they are more appropriately categorized within
a recognized, traditional asset class (e.g., securities with an effective registration
statement filed under the Securities Act of 1933 that are issued, stored, or transferred
through the system of a regulated clearing agency and in compliance with all applicable
federal and state securities laws). Custodia’s materials submitted in connection with its
application generally use the term “digital asset” instead of “crypto-asset.”
3
Confidential Exhibit A to the Application by Custodia Bank to the Board of Governors
of the Federal Reserve System for Membership in the Federal Reserve System—FR 2083
(August 5, 2021) (“Initial Business Plan”), at 2.
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a crypto-asset token it refers to as an “electronic negotiable instrument,” and crypto-asset
prime services. Custodia is not seeking deposit insurance from the Federal Deposit
Insurance Corporation (“FDIC”).
On August 5, 2021, Custodia submitted initial materials to apply for membership
in the Federal Reserve System. 4 In evaluating membership applications, the Board
considers the general character of the management of the applying bank (“managerial
factor”), the applying bank’s financial condition (“financial factor”), whether the
corporate powers to be exercised are consistent with the purposes of the Act (“corporate
powers factor”), and the convenience and needs of the community (“convenience and
needs factor”). 5 Based on its review of the record of Custodia’s membership
application, 6 the Board has fundamental concerns with Custodia’s proposal, including its
novel and unprecedented features, and has determined that approval of the membership
4
Application by Custodia Bank to the Board of Governors of the Federal Reserve
System for Membership in the Federal Reserve System—FR 2083 (August 5, 2021)
(“Initial Application”). In October 2020, Custodia made an initial, separate submission
to the Federal Reserve Bank of Kansas City (“Reserve Bank”) requesting a master
account. This order only relates to the Board’s consideration of the membership
application. The master account request is under separate consideration by the Reserve
Bank.
5
12 U.S.C. § 322; 12 CFR 208.3(b)(1)–(4). As part of the financial factor, the Board
considers the financial history and condition, capital adequacy, and future earnings
prospects of the applicant. 12 U.S.C. § 329; 12 CFR 208.3(b)(1)–(2).
6
As of October 21, 2022, Custodia asserted that the “application record should now be
considered complete.” Letter from Derek Bush to Jeffrey Imgarten dated October 21,
2022 (“Third AI Response”), at 2.
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application would be inconsistent with the financial, managerial, and corporate powers
factors. 7
Managerial Factor. The Board does not believe that approval of the application
would be consistent with the managerial factor. Banks admitted for membership in the
Federal Reserve System must have risk management systems and controls commensurate
with the nature, scope, and risks of the activities in their proposed business plans. In
general, the Board has heightened concerns about banks with business plans focused on a
narrow sector of the economy. 8 Those concerns are further elevated with respect to
Custodia because it is an uninsured depository institution seeking to focus almost
7
See 12 CFR 208.3(a)(2). When reviewing applications for membership, the Board’s
long-standing view has been that adverse considerations with respect to any individual
statutory factor may be sufficient grounds to support denial. This approach is consistent
with the Board’s review of applications under statutory factors in other contexts. See,
e.g., Florida National Banks of Florida, Inc., 62 Federal Reserve Bulletin 696, 698 (1976)
(denying the application by a company to retain voting shares in a bank acquired without
proper prior approval of the Board on the grounds of adverse managerial considerations
alone); Emerson First National Company, 67 Federal Reserve Bulletin 344, 345–46
(1981) (denying based on financial factors—including future prospects—alone); see also
Board of Governors v. First Lincolnwood Corp., 439 U.S. 234, 244–48 (1978) (holding
that the Board may “disapprove formation of a bank holding company solely on grounds
of financial or managerial unsoundness” under the Bank Holding Company Act and
noting “the similarity between these factors [under the Bank Holding Company Act] and
those specified in other banking statutes as the basis for admitting state banks to
membership in the Federal Reserve System”).
8
See, e.g., Green Dot Corporation, 98 Federal Reserve Bulletin 29, 32 (2011) (“A
business plan that focuses on a narrow business activity and depends on a limited number
of key business partners carries significantly greater risks than a business plan that
employs broad diversification of activities and counterparties. The Board expects
banking organizations with a narrow focus to address these increased risks with financial
resources, managerial systems, and expertise commensurate with that additional level of
risk.”) (internal citations omitted).
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exclusively on offering products and services related to the crypto-asset sector, which
presents heightened illicit finance 9 and safety and soundness risks. 10
Pre-membership examination findings are particularly insightful in relation to a
de novo charter because there is a lack of a management track record to review. The
findings of Federal Reserve staff’s pre-membership examination suggested significant
deficiencies in Custodia’s ability to manage the risks of its day-one activities, which
consist of limited basic banking services. Specifically, the findings indicated Custodia’s
risk management and controls for its core banking activities were insufficient,
particularly with respect to overall risk management; compliance with the Bank Secrecy
Act (“BSA”) and U.S. sanctions; information technology (“IT”); internal audit; financial
projections; and liquidity risk management practices.
Despite these deficiencies, Custodia has proposed to expand its operations soon
after approval for membership to focus almost exclusively on novel crypto-asset-related
activities and to accept only uninsured deposits—an unprecedented business model that
presents heightened risks involving activities that no state member bank previously has
been approved to conduct. As of the time of the pre-membership examination, Custodia
had not yet developed a sufficient risk-management framework for its proposed crypto-
asset-related activities, nor had it addressed the highly correlated risks associated with its
undiversified business model. Indeed, some products that are estimated to be significant
9
See infra part II.A.1.
10
See infra part II.C.2.
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sources of revenue were still in the “conceptualization phase,” and policies, procedures,
and processes related to planned crypto-asset-related activities remained in the early
stages of development, especially in the area of compliance. As such, at this time,
Custodia has been unable to demonstrate that it could conduct an undiversified business
focused on crypto-asset-related activities in a safe and sound manner and in compliance
with BSA and Office of Foreign Assets Control (“OFAC”) requirements.
In addition, the depth of relevant banking experience and bank-specific risk
management experience among Custodia’s board of directors and management team is
limited, and the information available is not sufficiently persuasive in demonstrating that
the proposed management team could conduct the proposed activities in a safe and sound
manner. The number and degree of shortcomings identified in the pre-membership
examination suggest that management’s experience is not commensurate with the firm’s
intended risk profile.
The proposal also presents potential concerns with respect to Custodia’s ability to
be resolved safely and effectively upon failure. Uncertainty regarding such an outcome
could contribute to instability and run risk at a time of stress for Custodia. Accordingly,
considerations relating to the managerial factor are so adverse as to present sufficient
grounds on their own for warranting denial of the application.
Financial Factor. The Board does not believe that approval of the application
would be consistent with the financial factor. The Board generally disfavors business
plans that “result in a concentration of assets, liabilities, product offerings, customers,
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revenues, geography, or business activity without effective mitigants.” 11 Without a
materially diversified business franchise, Custodia’s revenue and funding model relies
almost solely upon the existence of an active and vibrant market for crypto-assets.
However, crypto-asset markets have exhibited significant volatility. 12 The Financial
Stability Oversight Council (“FSOC”) has observed that the value of most crypto-assets
is driven in large part by speculation and sentiment, and is not anchored to a clear
economic use case. 13 Recent events, including the bankruptcies of crypto-asset
intermediaries Celsius, Voyager, BlockFi, and FTX, have highlighted that the global and
largely unregulated or noncompliant crypto-asset sector lacks stability and that
dislocations in the sector can result in stress at financial institutions focused on serving
the crypto-asset sector.
Given that Custodia only recently started operations, there is very limited financial
history to assess. While Custodia appears to have sufficient capital and resources to
sustain initial operations, Custodia’s pro forma financial statements assume that it would
be permitted to engage in several novel crypto-asset-related activities; indeed, Custodia’s
medium and long term viability would be dependent on engaging in such activities.
11
SR Letter 14-2/CA Letter 14-1: Enhancing Transparency in the Federal Reserve’s
Applications Process (February 24, 2014) (“SR Letter 14-2”).
12
Financial Stability Oversight Council, Report on Digital Asset Financial Stability
Risks and Regulation, at 9 (October 3, 2022) (“FSOC Report”), (“[Global crypto-asset]
market capitalization exhibited substantial volatility, rising, for example, from about
$200 billion in April 2020, to the November 2021 peak [of nearly $3 trillion], and later
falling as of July 2022 to a trough of about $900 billion.”).
13
FSOC Report, at 23–28.
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However, in the event Custodia’s application were to be approved, the Board would
prohibit Custodia from engaging in a number of those activities because Custodia has not
demonstrated that it can conduct the activities in a safe and sound manner and, in some
cases, also because the activities would be impermissible for a national bank. Without
the ability to conduct these crypto-asset-related activities, the financial condition,
including the future earnings prospects of the institution, is uncertain. Accordingly,
considerations relating to the financial factor are so adverse as to present sufficient
grounds on their own for warranting denial of the application.
Corporate Powers Factor. The Board does not believe that approval of the
application would be consistent with the corporate powers factor. Custodia’s proposed
business model would focus almost exclusively on the crypto-asset sector and would aim
to create further connections between traditional financial intermediaries and the crypto-
asset ecosystem by engaging in crypto-asset-related activities that are novel and
unprecedented for state member banks. Given the speculative and volatile nature of the
crypto-asset ecosystem, the Board does not believe that this business model is consistent
with the purposes of the Federal Reserve Act. Further, if the Board were to approve
Custodia’s membership application, it would prohibit Custodia from engaging in a
number of the novel and unprecedented activities it proposes to conduct—at least until
such time as the activities conducted as principal are permissible for national banks and
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Custodia can demonstrate that it can conduct the activities in a safe, sound, and compliant
manner. 14
Additionally, the admission of an uninsured deposit-taking institution to Federal
Reserve membership is unprecedented since the creation of federal deposit insurance in
1933 and requires careful consideration of the heightened micro- and macro-prudential
risks of wholly uninsured deposit-taking. 15 The absence of deposit insurance coverage at
Custodia could increase the firm’s risk of runs and contagion. This is especially
concerning because the global crypto-asset industry, on which Custodia has focused its
business model, is highly susceptible to runs, as recent events have demonstrated. 16
Even if granted membership, Custodia, as an uninsured depository institution,
would not be subject to a host of requirements tied to insured depository institution
status. 17 Further, the resolution of an uninsured deposit-taking institution would be
required to be conducted outside the FDIC’s proven and effective receivership process
14
See infra part II.C.
15
From 1934 until 1991, federal deposit insurance was granted as a condition of
membership in the Federal Reserve System to all member banks in the business of
accepting deposits other than trust funds. See Banking Act of 1933, Pub. L. No. 73-66,
48 Stat. 162, 172. Since the passage of the Federal Deposit Insurance Corporation
Improvement Act of 1991 (“FDICIA”), the Federal Reserve has not admitted to
membership a bank proposing to accept deposits from the general public that has not
been approved by the FDIC for deposit insurance. Pub. L. No. 102-242, 105 Stat. 2236
(1991).
16
See FSOC Report, at 46–53.
17
Moreover, any future parent company of Custodia likely would not be subject to
prudential supervision or regulation as a holding company because Custodia would be
uninsured and is not allowed to engage in lending and, therefore, would not be a “bank”
under the Bank Holding Company Act (“BHC Act”). 12 U.S.C. § 1841 et seq.
-8-
and instead would occur under a newly enacted and entirely untested Wyoming state law
resolution regime. Future applicants may present business models and control
frameworks to overcome the concerns presented by an uninsured deposit-taking bank, but
the Board does not believe that Custodia has overcome these concerns or provided
sufficient justification to break from long-standing precedent. Accordingly,
considerations relating to the corporate powers factor are so adverse as to present
sufficient grounds on their own for warranting denial of the application.
Convenience and Needs Factor. In addition to the statutory factors, under the
Board’s Regulation H, the Board considers the convenience and needs of the community
to be served. The Board has considered Custodia’s purported benefits to its community.
Custodia has not demonstrated that it could operate in a safe and sound manner as
proposed, which also indicates Custodia will not be able to meet the convenience and
needs of its community. Instead, the current record indicates Custodia could in fact pose
significant risk to its community. It is also unclear whether Custodia would be able to
comply with any applicable consumer protection requirements given the inherent features
of its intended business model.
* * *
In summary, the Board believes that approving Custodia’s application as
submitted would be inconsistent with the factors that the Board is required to consider.
There are significant deficiencies in Custodia’s risk management and controls framework
in relation to Custodia’s limited basic banking activities. Even if Custodia were able to
successfully remediate all issues identified with respect to its ability to safely and soundly
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conduct its limited day-one activities, conducting only this limited set of activities would
not enable it to constitute a viable bank in the medium or long term. Moreover, the future
earnings prospects of the business model that Custodia has proposed—that is, an
uninsured, undiversified, crypto-asset-focused business model featuring a number of
novel and untested activities posing heightened risks—is inconsistent with approval. In
light of concerns set forth herein, the Board has determined that considerations relating to
the managerial, financial, and corporate powers factors are so adverse as to each
independently warrant denial of application. The membership application is therefore
denied without prejudice to future applications by Custodia.
I. Background
Custodia (formerly called “Avanti”) is a de novo SPDI chartered by the state of
Wyoming. Custodia intends to focus on the crypto-asset sector and has described itself
as seeking to become a “compliant bridge” between the U.S. dollar payment system and
the crypto-asset ecosystem. 18 Wyoming state law enables the chartering of SPDIs, a new
type of financial institution that the state of Wyoming designed specifically to be able to
meet the financial services needs of crypto-asset-related businesses. 19 Under the
18
Initial Business Plan, at 2.
19
Wyoming specifically designed the Wyoming Special Purpose Depository Institutions
Act (“SPDI Act”), and other crypto-asset-related legislation and regulations, to foster the
establishment of a new type of financial institution to serve crypto-asset customers and
encourage blockchain innovation. See H.B. 0074, 65th Legislature, General Session
(Wyo. 2019), at 1–2; see also Wyoming Division of Banking, Special Purpose
Depository Institutions (accessed January 23, 2023), https://wyomingbanking
division.wyo.gov/banks-and-trust-companies/special-purpose-depository-institutions;
Carolyn Duren, Wyoming Aims to Become “Silicon Prairie” with 1st Cryptocurrency
- 10 -
Wyoming SPDI Act, Custodia may engage in a nonlending banking business, provide
payment services for depositors, and, with the approval of the state banking
commissioner, engage in any other activity that is usual or incidental to the business of
banking. 20
Wyoming law prohibits SPDIs from making loans and requires SPDIs to maintain
unencumbered assets valued at 100 percent of its depository liabilities or more; Wyoming
law allows SPDIs to meet the unencumbered-asset requirement by holding deposits at a
Federal Reserve Bank or federally insured financial institution, U.S. Treasury securities,
state and municipal bonds, and agency securities. 21 Custodia proposes to maintain,
during the first three years of its operations, reserves equal to at least 108 percent of
customer deposits in a Reserve Bank master account, if one is granted, subject to the
agreement of the Wyoming Division of Banking; after that period, Custodia proposes to
invest the funds associated with customer deposits in Federal Reserve Bank deposits,
Bank, S&P Global (September 23, 2020), https://spglobal.com/marketintelligence/en/
news-insights/latest-news-headlines/wyoming-aims-to-become-silicon-prairie-with-1st-
cryptocurrency-bank-60423622.
20
See Wyo. Stat. §§ 13-12-101 through 13-12-126.
21
Wyo. Stat. § 13-12-103(c); Wyo. Stat. § 13-12-105. Permitted assets include deposits
held at a Federal Reserve Bank or correspondent bank, obligations of the U.S. Treasury
or other federal agencies, obligations of U.S. states and municipalities that are investment
grade, securities issued by federal or state agencies or government-sponsored enterprises
that are investment grade, and any other investments deemed to be “substantially similar”
and “permissible under safe and sound banking practices” by the Wyoming Banking
Commissioner (which, according to Custodia’s Investment Policy, could include reverse
repurchase agreements fully collateralized by U.S. Treasuries). Wyo. Admin. Code 21-2-
20 § 9(a). The investments must be level 1 High-Quality Liquid Assets as defined under
12 CFR 249.20, unless approved by the Commissioner. Wyo. Admin. Code. 21-2-20
§ 9(b).
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deposits at federally insured depository institutions, Treasury securities with maturities of
three months or less, or reverse repurchase agreements on Treasury securities. 22
Wyoming law does not require SPDIs to obtain federal deposit insurance, and Custodia is
not seeking to obtain federal deposit insurance. 23
Because Custodia will not have federal deposit insurance, 24 there are significant
gaps in the applicable federal legal and prudential framework. As an uninsured
institution, a range of requirements tied to insured depository institution status would not
apply. For example, Custodia would not be subject to the Change in Bank Control Act 25
or the Community Reinvestment Act. 26 In addition, as a nonbank for purposes of the
BHC Act, any entity that controls, or is under common control with, Custodia would be
outside the scope of the BHC Act’s activities restrictions and consolidated prudential
supervision and regulation. 27
22
Letter from Derek Bush to Jeffrey Imgarten dated July 22, 2022 (“First AI
Response”), at 15–17; Custodia Bank, Inc., Investment Policy (July 19, 2022) (part of
Confidential Exhibit D to the First AI Response) (“Investment Policy”), at 3–5.
23
All Wyoming state-chartered banks, except SPDIs, must obtain FDIC insurance.
Wyo. Stat. § 13-2-103(a).
24
Even though it is a depository institution, Custodia contends that it is functionally
similar to a nondepository national trust company and has asserted that some national
trust companies do not have FDIC insurance. Initial Business Plan, at 114. There are
currently no uninsured member banks that accept deposits from the general public.
25
12 U.S.C. § 1817(j).
26
12 U.S.C. § 2901 et seq.
27
See supra note 17.
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Custodia was granted an SPDI charter from the state of Wyoming in
October 2020. 28 On August 5, 2021, Custodia submitted initial materials to apply for
membership in the Federal Reserve System pursuant to section 9(1) of the Act. 29
Custodia received a certificate of authority to operate from the state of Wyoming on
September 12, 2022. 30 Custodia commenced operations on October 11, 2022. Custodia
intends to begin accepting deposits in early 2023.
Custodia proposes to operate as a “digital bank ” and plans
to operate in all 50 states within its first of operation. 31 Custodia has based its
growth assessments on the judgment that “
” and that there would not be “
.” 32 Custodia proposes to offer its services to
non-U.S. customers after of operation. 33
A. Custodia’s Proposed Business Model
Custodia’s membership application indicates that it would follow a novel business
model—a digital banking platform offered globally, with no branches—focused on fee
revenue by serving the crypto-asset industry across four core business lines: Payments–
28
Initial Business Plan, at 2; see also Public Exhibit D to the Initial Application.
29
12 U.S.C. § 321; Initial Application. There is a 1-year time limit on agency
consideration of a completed application. 12 U.S.C. § 4807.
30
Third AI Response, at 13.
31
Initial Business Plan, at 39.
32
Initial Business Plan, at 92.
33
First AI Response, at 3, 44.
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Core Banking; Custody; Payments–Avit; and Prime Services. 34 Custodia intends to offer
these services primarily to businesses conducting crypto-asset-related activities, 35 but
would later offer such services to high-net-worth individuals that maintain large
minimum balances. 36
1. Payments–Core Banking
Custodia plans to offer deposit accounts for businesses and eventually high-net-
worth individuals 37 and, in connection, would provide such customers access to ACH and
wire transactions, , and online banking services. 38 Custodia plans to
target core banking business from crypto-asset-related customers that it believes are
currently underserved in this area, 39 and for the core banking business line to be available
34
Initial Business Plan, at 6. Custodia would also develop an application programming
interface (“API”) for its services, allowing third parties to develop custom software
integrations . See Initial Business Plan, at 8, 15–17;
see also Confidential Exhibit B to the Initial Application, at 6, 10. Custodia would offer
API services to “ .” Letter from Derek Bush to
Jeffrey Imgarten dated August 19, 2022 (“Second AI Response”), at 32.
35
Custodia anticipates that its customers would include
.” Initial Application, at 7.
36
Initial Business Plan, at 10; First AI Response, at 3; Second AI Response, at 3–4;
Third AI Response, at 13–14.
37
While Wyo. Stat. § 13-12-104(a)(i) prohibits SPDIs from taking deposits from natural
persons, Custodia indicates that the Wyoming Division of Banking has interpreted Wyo.
Stat. § 13-12-104(d) to allow for natural persons to be depositors as an activity that is
incidental to the business of banking. Third AI Response, at 13–14.
38
Initial Business Plan, at 8–9; First AI Response, at 2, 7–8.
39
Initial Application, at 7–8; see also Initial Business Plan, at 53–60.
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when . 40 The core banking business line also would be
integral to Custodia’s proposed future business lines, particularly custody 41 and Avit. 42
2. Custody
Custodia plans to custody crypto-assets under different arrangements:
. 43
40
Initial Business Plan, at 7; First AI Response, at 2, 7–8. While Custodia represents its
core banking services are an important feature of the proposed crypto-asset-related
business, a material aspect of Custodia’s value-add proposition and potential for revenue
generation is the subsequent addition of crypto-asset-related operations in conjunction
with traditional banking products and services. From provided revenue projections,
First AI Response,
at 4.
41
See, e.g., Initial Business Plan, at 60 (“
).
42
See Initial
Business Plan, at 13–15.
43
Initial Business Plan, at 10–11; Second AI Response, at 21–23.
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Custodia would send and receive crypto-assets on behalf of customers under each
of these custodial arrangements. 44 Custodia would also conduct private key management,
wherein it would act as a signatory on one of the keys in a multi-party, multi-signature
arrangement, . 45 Finally,
Custodia would
. 46
Custodia asserts that it must hold a small amount of bitcoin and ether as principal
in order to pay transaction fees on behalf of customers in order to offer custody
services. 47 Custodia argues that prudent risk management requires it to distribute large
custody transfers and balances across multiple addresses to mitigate cyber theft risk and
that it must pay transaction fees associated with these transfers using crypto-assets from
its own account because the transfers are conducted at Custodia’s direction, rather than at
44
Initial Business Plan, at 10–11. Custodia would also
Id., at 11.
45
Initial Business Plan, at 11; Second AI Response, at 22.
46
Initial Business Plan, at 10–11; Second AI Response, at 22–23.
47
First AI Response, at 18, 39 n.97; Second AI Response, at 24–25 (“Custodia must pay
on-chain transaction fees both in respect of customer transactions and in relation to the
risk management of these customer transactions.”). Custodia indicates that it expects to
hold worth of crypto-assets as principal at any one time. Under
Custodia’s proposed Investment Policy, however, it would be authorized to hold up to
in crypto-assets. First AI Response, at 18; Investment Policy,
at 4–5.
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the direction of the customer. 48 Custodia has also asserted that Wyoming law requires it
to hold certain crypto-assets as principal in order to custody crypto-assets because crypto-
asset custodians must have on hand sums required for the execution of transactions. 49
Custodia plans for a limited version of its custody business line—providing
custody services only for bitcoin—to be available by . 50 Custodia
plans to launch custody services for ether around . 51
48
Second AI Response, at 24–25. When asked about alternatives, Custodia
acknowledged that it is possible to conduct customer-directed transactions without paying
transaction fees from crypto-assets in its own account in four ways but insisted that the
options were not feasible. First, Custodia could
. However, Custodia argues that this model
would burden its proposed business model by increasing the risk a transaction fails, as
this approach would
. Id.
Second, Custodia could
Third AI Response, at 19–21. Custodia states it “
thus
defeating the purpose of in the first place.” Id., at 21. Third, Custodia could
;
however, Custodia states “would not be feasible due to
.” Id., at 20. Fourth, Custodia could “ ;”
however, Custodia states that the approach would “increase operational risk” and “result
in a poor customer experience.” Id., at 21.
49
First AI Response, at 12 n.31 (“
.”), 18 n.50, 39 n.97
(“
” citing Wyo. Admin. Code 21-2-19 § 8(a));
Investment Policy, at 4–5.
50
First AI Response, at 2.
51
Id., at 3.
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3. Payments–Avit
Custodia plans to issue, redeem, and transfer Avits—dollar-denominated tokens
that Custodia describes as programmable “electronic negotiable instrument[s]” 52 and as
deposits for purposes of federal banking law. 53 Avits are designed to facilitate delivery-
versus-payment transactions between counterparties transacting in crypto-assets by
increasing the velocity of crypto-asset transactions and removing counterparty credit risk
in U.S. dollar/crypto-asset transactions resulting from settlement timing mismatch. 54
While Custodia does not refer to Avits as “stablecoins,” the tokens would likely function
similar to “stablecoins” like Tether and USDC. 55
52
Initial Business Plan, at 9 (“Avit has no direct analogue to an existing payment
product. Avits are not legal tender, securities, or commodities.”), 98–102, 117–118; First
AI Response, at 8 (“Avit is an electronic negotiable instrument, representing a claim on
bank assets; it is a bank obligation issued as the electronic equivalent of a promissory
note, which can be endorsed to a new transferee and can be redeemed by the most recent
transferee.”), 14; Third AI Response, at 24–28, 31–32.
53
First AI Response, at 9 (“For banking law purposes, an Avit is a deposit, representing
a digital equivalent of a cashier’s check.”), 32 (stating that Avit would be “100% backed
by risk-free assets, which will be held in Custodia’s Federal Reserve Master Account,
pending approval”); Initial Business Plan, at 31 (“[A]n Avit is likely to be treated as a
bank deposit by the [Internal Revenue Service]”).
54
Initial Business Plan, at 9–10, 27–28.
55
Custodia has stated that Avits are not stablecoins, but “a new payment technology.”
Initial Business Plan, at 9. Custodia states that the “Avit could satisfy some of the
demand for stablecoins” and that users would “primarily include
.” Initial Business Plan, at 108. Custodia’s growth and fee
assumptions for Avits are based on
Custodia Bank,
Inc., Support for Digital Asset Assumptions (September 30, 2022) (Confidential Exhibit I
to Letter from Caitlin Long to Ross Crouch dated December 20, 2022).
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Custodia would issue Avits on Ethereum, a public blockchain, 56 and Liquid, a
sidechain of the Bitcoin blockchain, 57 and would back each Avit with one dollar in funds
held in a master account at the Federal Reserve, if such account is granted. 58 Custodia
states that under this structure an Avit would be a U.S. dollar-denominated “electronic
transferable record” under the Uniform Electronic Transactions Act, providing its holder
with rights similar to those of holders of a cashier’s check or a promissory note. 59
Ownership of and transactions with Avits would not be limited to customers of Custodia.
Persons unknown to Custodia would be able to purchase Avits on the secondary market
56
A defining feature of a public blockchain is that it is “open to the public, and anyone
can participate as a node in the decision-making process.” Imran Bashir, Mastering
Blockchain 26 (3d ed. 2020); see also Ethereum.org, Intro to Ethereum (accessed
January 23, 2023), https://ethereum.org/en/developers/docs/intro-to-ethereum/.
57
A sidechain is a blockchain with its own consensus mechanism and set of nodes that is
connected to another blockchain through a two-way bridge. Loïc Lesavre et al.,
Blockchain Networks: Token Design and Management Overview, at 73, National
Institute of Standards and Technology Internal Report No. NIST IR 8301 (February
2021). Liquid relies on the Bitcoin blockchain in that Liquid’s native asset, L-BTC, is
issued to a participant that sends a corresponding amount of bitcoin to a wallet controlled
by the Liquid network. Blockstream, How Does Liquid Bitcoin (L-BTC) Work?
(accessed January 23, 2023), https://help.blockstream.com/hc/en-us/articles/
900001408623-How-does-Liquid-Bitcoin-L-BTC-work-. Liquid’s consensus mechanism
and governance differs from that of the underlying Bitcoin blockchain, allowing
transactions on the sidechain to settle more quickly; see also Second AI Response, at 8–9.
58
First AI Response, at 29–34. Custodia states that the Wyoming Division of Banking
requires Avits to be “
” First AI Response, at
32 n.86.
59
See, e.g., Initial Business Plan, at 117–19; First AI Response, at 8–9.
- 19 -
and use them to conduct transactions. 60 Custodia has also indicated that noncustomers
would be able to redeem Avits after a screening process without being required to
become customers of Custodia. 61 Both customers and noncustomers of Custodia would
be able to hold Avits in custody arrangements or unhosted wallets; deposit Avits with
crypto-asset lenders, brokers, or exchanges; trade Avits for other crypto-assets on
secondary exchanges; invest or stake Avits in decentralized finance protocols; and use
Avits as part of smart contracts. 62
Custodia has represented that it is in the process of finalizing its terms and
conditions relating to Avits and that these terms will not be available until
. 63 As of
October 2022, Custodia estimated that it planned to launch Avits within
“ ,” . 64
60
First AI Response, at 14 (“Custodia will issue Avits only to customers of Custodia.
However, because Avits will be issued on a public blockchain, customers of Custodia
would be free to transfer Avits to non-customers of Custodia. As a result, non-customers
of Avits could come to hold Avits.”); see also Second AI Response, at 38–40; First AI
Response, 26–29 (indicating Custodia would only conduct risk-based due diligence of
non-customers transacting in Avits under specific circumstances).
61
See, e.g., First AI Response, at 44–45; Second AI Response, at 5; Third AI Response,
at 39.
62
First AI Response, at 24–29.
63
Third AI Response, at 22–23.
. See Confidential Exhibit B to the First AI Response.
64
Third AI Response, at 22.
- 20 -
4. Prime Services
Custodia states that its prime services business line would provide customers with
an on- and off-ramp to the crypto-asset ecosystem. 65 The main components of this
business would entail allowing customers to buy and sell qualifying crypto-assets through
Custodia’s platform. 66 Under this offering, a Custodia customer with an adequate deposit
balance could use the Custodia platform to request a bid for purchases and sales of
qualifying crypto-assets, and Custodia’s platform would request bids from “
.” 67 The best bid would be provided to Custodia’s customer for
acceptance, and Custodia’s platform would enable coordinated
settlement of both legs of the transaction. 68
Separately, Custodia would offer a platform that enables customers to borrow and
lend crypto-assets held in trust accounts at Custodia for a fee. 69 For the lending business,
Custodia would
65
Initial Business Plan, at 11–12; First AI Response, at 11; Second AI Response, at 15.
66
Initial Business Plan, at 11–12, 15–18, 69.
67
Initial Business Plan, at 15–18.
68
Id.; see also id., at 34 (“
.”).
69
Id., at 11–12; First AI Response, at 13, 35; Second AI Response, at 2–3, 15–16, 19–
20. Custodia is prohibited from lending out crypto-assets held on behalf of customers.
See Wyo. Stat. § 34-29-104(k) (prohibiting rehypothecation of crypto-assets).
- 21 -
. 70 Custodia would also offer
. 71
Custodia plans to initially offer prime services as soon as
. 72 It has represented that prime services would initially be offered
. 73
5. Activities Considered in Combination
While there is no agreed-upon taxonomy of crypto-asset-related functions or
activities, the services that Custodia would provide to customers serve a similar function
as many of the services offered by so-called crypto-asset exchanges. Crypto-asset
exchanges allow customers to purchase and sell crypto-assets in exchange for national
currency or other crypto-assets; facilitate lending of crypto-assets; 74 and offer custody
70
Second AI Response, at 2–3, 19, 24; Third AI Response, at 16.
71
See, e.g., Initial Business Plan, at 11–12, 18–20; First AI Response, at 11; Second AI
Response, at 15.
72
First AI Response, at 2–3. Custodia would be required to receive prior written
approval from the Wyoming Commissioner of Banking before commencing prime
services and must inform the Commissioner that it meets the enhanced crypto-asset
custody requirements under Wyo. Stat. § 13-12-103(b)(vii).
. Id., at 6–7.
73
First AI Response, at 35–36.
74
See, e.g., Order Instituting Proceedings Pursuant to Section 6(c) of the Commodity
Exchange Act, Making Findings, and Imposing Remedial Sanctions, In re iFinex Inc.,
BFXNA Inc., and BXFW Inc., Commodity Futures Trading Commission Docket No. 22-
05, at 3 (October 15, 2021) (“During the Relevant Period, the substantial majority of
- 22 -
services with respect to crypto-assets. 75 Many crypto-asset exchanges also issue
stablecoins or are closely connected to entities that issue stablecoins. 76
Indeed, crypto-asset exchanges rely significantly on those services for revenue, 77
as Custodia also would. 78 While Custodia represents that its business model differs from
margin trading was financed through Bi[t]finex’s peer-to-peer (‘P2P’) funding program.
Through P2P, Bitfinex customers who held fiat or cryptocurrency in their Bitfinex
account would ‘lend’ those funds to other Bitfinex customers.”).
75
Peter Mell and Dylan Yaga, Understanding Stablecoin Technology and Related
Security Considerations, at 40, National Institute of Standards and Technology Internal
Report No. NIST IR 8408 (October 2022) (initial public draft); see also Coinbase Global,
Inc. (“Coinbase”), Form 10-Q (May 10, 2022).
76
See, e.g., Binance, Understanding BUSD and Binance-Peg BUSD (November 15,
2022) (BUSD and Binance), https://www.binance.com/en/blog/ecosystem/understanding-
busd-and-binancepeg-busd-5526464425033159282; Concord Acquisition Corp Form 8-
K, Exhibit 99.6, at 11 (July 7, 2021) (USDC and Coinbase); Press Release, New York
Department of Financial Services, DFS Continues to Foster Responsible Growth in New
York’s Fintech Industry with New Virtual Currency Product Approvals (September 10,
2018), https://www.dfs.ny.gov/reports_and_publications/press_releases/pr1809101
(GUSD and Gemini); Settlement Agreement, In re Investigation by Letitia James,
Attorney General of the State of New York, of iFinex, Inc., et al. (February 17, 2021)
(Tether and Bitfinex).
77
At least one crypto-asset exchange relies on fees for crypto-asset-related services,
particularly services that allow customers to buy and sell crypto-assets, for substantially
all of its revenue. See, e.g., Coinbase, Form 10-Q, at 20–21 (May 10, 2022) (stating that
nearly 90 percent of total revenue is from “transaction fees earned from customers that
are primarily individuals” as well as institutional customers through the company’s
“crypto-asset matching service when customers buy, sell, or convert crypto-assets on the
platform”); Coinbase, Form 10-Q, at 24–25 (November 3, 2022) (stating transaction fees
from that “matching service” account for over 60 percent of total revenue).
78
First AI Response, at 4 (estimating that fees from prime services and custody business
lines, which are likely directly attributable to crypto-asset-related activity, would account
for ).
- 23 -
those of crypto-asset exchanges, 79 Custodia proposes to offer some of the same services
that are central to the operations of crypto-asset exchanges, albeit to a more limited
customer base. 80
B. Review of Custodia’s Application
Federal Reserve staff has had regular meetings with Custodia and has sent detailed
requests for additional information, to which Custodia has provided responses. In
addition, Reserve Bank examiners conducted a pre-membership examination of Custodia,
which concluded in October 2022. The examination focused only on Custodia’s core
banking products because the technology and risk management infrastructures to support,
facilitate, and execute the crypto-asset-related businesses (that is, custody, Avit, and
prime services) were in the early stages of development.
79
Initial Business Plan, at 69 (“[Custodia] is not an exchange
”); id., at 15, 33. Some crypto-asset
exchanges offer services and products that Custodia does not currently propose to
conduct, such as offering direct financing for margin lending, conducting proprietary
trading, or acting as a counterparty to transactions, among other activities. Such
activities, however, do not appear to account for a substantial share of revenue for at least
one crypto-asset exchange. See, e.g., Coinbase, Form 10-Q, at 20–23 (May 10, 2022);
Coinbase, Form 10-Q, at 24–27 (November 3, 2022).
80
Many so-called crypto-asset exchanges primarily serve retail customers and also
provide services, including custody and prime services, to institutional clients. See, e.g.,
Coinbase, Form 10-Q, at 24–25 (November 3, 2022); Gemini, Fund Managers and ETF
Issuers (accessed January 23, 2023), https://www.gemini.com/institutions/fund-
managers; Kraken, Institutions (accessed January 23, 2023), https://www.kraken.com/
institutions. Custodia would serve institutional customers and high-net-worth
individuals. See supra note 36; see also Initial Business Plan, at 71.
- 24 -
With respect to core banking products and services, the examiners identified a
number of significant risk management gaps, including in relation to the anti-money-
laundering (“AML”) requirements of the BSA and requirements relating to OFAC
sanctions; IT; internal audit; financial projections; and liquidity risk management
practices. 81 As a result, at the time of the examination, Custodia’s risk management
practices included numerous deviations from safe and sound banking practices typically
expected or required of a state member bank under Federal Reserve supervision.
Custodia has represented that remediation efforts are underway to address these
deficiencies, and potential follow-up examination work would be necessary to assess the
organization’s plans or work to address the gaps. 82 However, the cited deficiencies in
Custodia’s risk management related to its offerings of core banking products and services
negatively reflect on Custodia’s ultimate capacity to offer novel crypto-asset-related
products in a safe and sound manner, especially given the heightened risks associated
with those products. More importantly, given that many of Custodia’s underlying
policies, procedures, systems, and risk controls for the key proposed crypto-asset-related
activities still remain under development 83—despite Custodia’s having had time to
81
See Letter from Jeffrey Imgarten to Board of Directors of Custodia Bank, Inc., dated
October 21, 2022, at 2–6.
82
See infra note 112.
83
See generally First AI Response, Second AI Response, and Third AI Response. On
the afternoon of October 21, 2022, the Reserve Bank sent a letter to Custodia setting out
the results of the pre-membership examination and describing significant risk
management gaps, including deficiencies in BSA/AML/OFAC programs, IT, and internal
audit. See supra note 81. Such outstanding items had been previously communicated to
- 25 -
address these issues since application materials were initially submitted and despite the
importance of the crypto-asset-related activities to Custodia’s business model—it is not
currently possible to conclude that the envisioned risk management program, if finalized,
would sufficiently address concerns about Custodia’s ability to operate the crypto-asset-
related activities in a safe and sound manner, and in compliance with applicable
regulations and requirements.
II. Analysis of Statutory Factors
In acting on an application for membership in the Federal Reserve System, the
Board considers (A) the general character of the bank’s management; (B) the financial
condition of the bank; (C) whether or not the bank’s corporate powers are consistent with
the purposes of the Act; and (D) the convenience and needs of the community to be
served by the bank. 84 In addition, all state member banks are required to establish and
maintain programs for compliance with the BSA. 85
A. Managerial Considerations
In reviewing the managerial factor, the Board has considered Custodia’s ability to
monitor and control financial, operational, compliance, and legal risks, including
Custodia’s management orally. Several hours after confirming receipt of the letter,
Custodia submitted its Third AI Response in which it informed the Federal Reserve that,
in its estimation, the “application record should now be considered complete” despite the
outstanding items raised by the pre-membership examination. Third AI Response, at 2.
84
12 U.S.C. § 322; see also 12 CFR 208.3(b)(1)–(4). As part of considering the
financial condition of the bank, the Board considers the financial history and condition,
capital adequacy and future earnings prospects of the applicant. 12 U.S.C. § 329; 12
CFR 208.3(b)(1)–(2).
85
12 CFR 208.62; 208.63.
- 26 -
BSA/OFAC compliance risk. 86 The Board has also considered the experience of
Custodia’s proposed management and the adequacy of its risk management systems and
operations, and the applicable resolution framework.
1. BSA and OFAC Compliance
AML and OFAC compliance programs are reviewed in part because they reflect
on the soundness of management and the safety and soundness of the institution.
Identified weaknesses in AML and OFAC compliance programs can raise concerns about
whether a company’s managerial resources are consistent with approval of the
application. 87 In this case, examiners identified compliance program deficiencies with
respect to Custodia’s limited core banking activities. More importantly, given the
absence of developed policies, procedures, and controls for crypto-asset-related activities
at this stage, the examiner findings suggest that Custodia is unlikely to be able to
effectively comply with the BSA and OFAC requirements applicable to the proposed,
more complex, higher-risk crypto-asset-related activities that are central to its business
model.
Legal Framework. In the United States, money laundering and terrorist financing
(“ML/TF”) concerns are primarily addressed through the legal requirements of the BSA
86
See SR Letter 16-11, Supervisory Guidance for Assessing Risk Management at
Supervised Institutions with Total Consolidated Assets Less than $100 Billion
(February 17, 2021).
87
See, e.g., M&T Bank Corporation, FRB Order No. 2015-27, at 11 (September 30,
2015); see also SR Letter 14-2.
- 27 -
and the economic and trade sanctions administered by OFAC. 88 The BSA requires
financial institutions to establish, implement, and maintain an effective and reasonably
designed AML program. 89 BSA regulations require banks and certain other financial
institutions to perform due diligence to understand the nature and purpose of the
customer relationship; perform ongoing monitoring to identify and report suspicious
activity; and verify the identity of a new customer. 90
88
While financial regulators, including the Board, review financial institutions for
compliance with these requirements through regulation, supervision, and enforcement,
the principal administrators of the BSA and U.S. economic sanctions are the Financial
Crimes Enforcement Network (“FinCEN”) and OFAC, respectively.
89
The AML compliance program must provide for the following requirements: (i) a
system of internal controls to assure ongoing compliance; (ii) independent testing for
compliance to be conducted by bank personnel or by an outside party; (iii) designation of
an individual or individuals responsible for coordinating and monitoring day-to-day
compliance (BSA compliance officer); (iv) ongoing training for appropriate personnel;
and (v) appropriate risk-based procedures for conducting ongoing customer due
diligence. See 31 CFR parts 1020 through 1030.
90
Banking organizations must establish and maintain procedures reasonably designed to
assure and monitor compliance with BSA regulatory requirements, which should be
commensurate with the institution’s size, complexity, and business activities. See, e.g.,
12 CFR 208.63, 211.5(m), 211.24(j) (Federal Reserve); 31 CFR 1020.210 (FinCEN);
Federal Financial Institutions Examination Council, Bank Secrecy Act/Anti-Money
Laundering Examinational Manual, at 21–22 (April 2020). Underlying BSA regulatory
requirements include, among other things, (i) obtaining information identifying and
verifying a new customer opening an account (31 CFR 1020.220); (ii) conducting
ongoing risk-based customer due diligence (31 CFR 1020.210(a)(2)(v)); (iii) identifying
and verifying the identity of beneficial owners of legal entity customers (31 CFR
1010.230); (iv) conducting ongoing monitoring to identify and report suspicious
transactions (12 CFR 208.62, 211.5(k), 211.24(f) (Federal Reserve), 31 CFR 1020.320
(FinCEN)); (v) obtaining and retaining records for certain payment orders (commonly
referred to as “Funds Transfers Recordkeeping”) (31 CFR 1020.410(a), 31 CFR
1010.410(e)); and (vi) transmitting, among other things, the names of the originator and
beneficiary on certain transactions (commonly referred to as the “Travel Rule”) (31 CFR
1010.410(f)).
- 28 -
OFAC requires all U.S. persons to comply with U.S. economic and trade
sanctions. Moreover, to prevent prohibited transactions from flowing through the
institutions and ensure their compliance with OFAC sanctions, most financial institutions
and all banks, with OFAC’s and regulators’ encouragement, develop and implement a
sanctions compliance program.
Banks structure their compliance programs to be risk-based and to identify and
report potential ML/TF and other illicit financial activity. Banks assess their individual
exposure to the risk of money laundering, terrorism finance, and financial crime based on
the composition of their customer base, geographies served, and financial products and
services offered. Banks must properly manage customer relationships and effectively
mitigate risks by implementing controls commensurate with those risks. Federal banking
agency examiners evaluate the adequacy of a bank’s AML compliance program relative
to its risk profile to assess whether a bank has developed and implemented effective
processes to identify, measure, monitor, and control risks.
Heightened Risks Related to Crypto-Assets. Crypto-assets pose significant
ML/TF risks due to the lack of transparency, ease and speed of transfer, and general
irrevocability of transactions—all of which make crypto-assets attractive for use in
money laundering. 91 The ability to conduct instantaneous transactions electronically—
91
See Department of the Treasury, National Money Laundering Risk Assessment and
National Terrorist Financing Risk Assessment, at 40–45 (February 2022) (“2022 National
Risk Assessment”); Department of the Treasury, National Strategy for Combating
Terrorist and Other Illicit Financing (May 13, 2022); Department of Justice, The Role of
Law Enforcement in Detecting, Investigating, and Prosecuting Criminal Activity Related
- 29 -
especially in a programmable manner that allows rapid, repeatable transactions—makes it
possible to facilitate numerous small transactions through multiple accounts in order to
move large sums. Such small transactions are very difficult for financial institutions’
transaction monitoring systems to identify as suspicious activity.
The ability to identify users and monitor transactions is central to mitigating
ML/TF risks, but crypto-assets often afford their holders significant anonymity. Users
may transact through unregulated or less regulated money services businesses in a
country lacking a robust AML/Combating Financing of Terror (“CFT”) regime, and
financial transparency may be further decreased by crypto-assets held by users in
“unhosted wallets.” 92 Trading in crypto-assets is often conducted pseudonymously either
on a peer-to-peer basis 93 or through facilitation by lightly regulated or unregulated
intermediaries. 94 Crypto-asset trading can occur globally, and there are few to no limits
to Digital Assets (September 6, 2022); and FinCEN, Advisory on Illicit Activity
Involving Convertible Virtual Currency, FIN-2019-A003 (May 9, 2019).
92
“An unhosted wallet is not hosted by a third-party financial system. It can be very
difficult or impossible to determine who is accessing or in control of the use of
cryptocurrencies in an unhosted wallet. Unhosted wallets allow for anonymity and
concealment of illicit financial activity.” Department of the Treasury, Requirements for
Certain Transactions Involving Certain Convertible Currency or Digital Assets
Frequently Asked Questions (FAQs) (December 18, 2020). See Requirements for
Certain Transactions Involving Convertible Virtual Currency or Digital Assets, 85
Federal Register 83840, 83843–44 (proposed December 23, 2020) (“FinCEN Proposed
Requirements”).
93
See, e.g., Press Release, FinCEN Penalizes Peer-to-Peer Virtual Currency Exchanger
for Violations of Anti-Money Laundering Laws (April 18, 2019),
https://www.fincen.gov/news/news-releases/fincen-penalizes-peer-peer-virtual-currency-
exchanger-violations-anti-money.
94
See, e.g., 2022 National Risk Assessment, at 42–45.
- 30 -
on cross-border transactions. While a financial institution can require customer
identification information in connection with a customer onboarding process (e.g., with
respect to custody customers), it can be very difficult for a financial institution that is an
issuer of crypto-assets to identify holders of such assets in circulation, unless holders of
the asset are limited to identified customers only. 95
A financial institution’s ability to limit the misuse of crypto-assets for ML/TF
depends in large part on the internal controls in place at points where crypto-assets
interact with the traditional financial system, such as when a crypto-asset is obtained by a
user in exchange for national currency. 96 Stablecoins, however, may reduce the need for
crypto-asset holders to interact with regulated institutions. 97 Because a stablecoin’s value
is derived from the value of a currency, a group of currencies, or a commodity, there is
generally no reason to hold stablecoins for investment, as they merely represent the value
95
See, e.g., Press Release, FinCEN Advises Increased Vigilance for Potential Russian
Sanctions Evasion Attempts (March 2022), https://fincen.gov/sites/default/files/2022-
03/FinCEN%20Alert%20Russian%20Sanctions%20Evasion%20FINAL%20508.pdf;
2022 National Risk Assessment, at 41–42; FinCEN, Advisory on Illicit Activity
Involving Convertible Virtual Currency, FIN-2019-A003 (May 9, 2019).
96
Even with these controls in place, misuse of crypto-assets for money laundering
frequently occurs. FinCEN and OFAC enforcement actions are commonly taken due to
failure to implement adequate controls as required by regulations. Agencies—including
FinCEN, OFAC, and the Department of Justice—have taken numerous public
enforcement actions against entities or individuals dealing in crypto-assets. See, e.g.,
2022 National Risk Assessment, at 41–45.
97
See President’s Working Group on Financial Markets et al., Report on Stablecoins, at
19–21 (November 2021) (“PWG Stablecoin Report”). As noted in the PWG Stablecoin
Report, “[c]riminals often use the most common and liquid forms of value for ML and
TF, and mass-adopted stablecoins or other digital assets may be attractive to illicit actors,
which could heighten ML/TF risks.” Id.
- 31 -
of another already available store of value. 98 The holder of a stablecoin may instead be
seeking a medium of exchange that could offer faster settlement, access to crypto-asset
markets, cross-border capabilities, and anonymity relative to other payment forms. 99 The
holder of a widely used stablecoin may have no need to redeem it for national currency at
the issuer, but instead could sell it on the secondary markets in exchange for other crypto-
assets or national currency. Indeed, stablecoins can circulate continuously, quickly,
pseudonymously, and indefinitely. While the financial institution that issued the
stablecoin might have information on the transaction flows on the applicable blockchain,
it would likely not know the identity of the transactors other than the initial purchaser and
the ultimate redeemer. 100 Without information about the transactors, it is extremely
98
Stablecoins, by design, do not appreciate in value and typically do not pay interest to
holders. Stablecoin holders forgo appreciation and interest and incur additional
counterparty risk in order to access crypto-asset markets. Holders may, however, lend
stablecoins back to crypto-asset intermediaries or protocols (including, in some cases, the
stablecoin issuer) to earn interest. See Will Rising Interest Rates Damage Stablecoins,
PYMNTS (July 25, 2022), https://pymnts.com/cryptocurrency/2022/will-rising-interest-
rates-damage-stablecoins/.
99
PWG Stablecoin Report, at 7–11.
100
While there are private companies that investigate transactions on crypto-asset
blockchains solely based on public information, such as from the blockchain or social
media, without customer identification information, the services are highly imperfect.
Law enforcement and specialist blockchain analytics firms, like Chainalysis, can learn
information about a wallet and its holder, including whether the wallet may be associated
with illicit activity or other wallets identified as suspicious or sanctioned; however, it can
be difficult, relying on blockchain analysis alone, to establish the real-world identity of
the person with ownership or control of a wallet with available information at the time of
the transaction. Even following an investigation, such information can be difficult to
establish, particularly if blockchain obfuscation techniques are used. See, e.g., C. Alden
Pelker, Christopher B. Brown, Richard M. Tucker, Using Blockchain Analysis from
Investigation to Trial, 69 Department of Justice Journal of Federal Law and Practice 59,
62–63 (2021).
- 32 -
difficult for financial institutions to comply with AML/CFT requirements to identify
suspicious activity and sanctioned parties, especially within mandated reporting
periods. 101
The pseudonymity of crypto-asset transactions may also lead to financial
institutions unknowingly but directly engaging in what may result in illicit financial
activity. Crypto-asset transactions on some blockchains, including Ethereum, rely on
distributed networks of anonymous persons for validation. 102 Validators perform this
service in exchange for earning crypto-assets, which may take the form of an award for
validations (for bitcoin “miners”) or a tip from transactors as payment for the validation
(“transaction processing fees”). 103 These transaction processing fees on some
blockchains, including Ethereum, go to unknown validators, which may include illicit
actors or sanctioned entities. 104 To the extent a financial institution pays such transaction
101
See, e.g., 31 CFR 1020.320(b)(3); 12 CFR 208.62(d).
102
For example, on Ethereum, one of the two blockchains Custodia proposes to use (see
Third AI Response, at 16–17), no screening or diligence is done to determine if validators
are sanctioned persons. Stereum, ETH Solo Staking Guide (accessed January 23, 2023),
https://stereum.net/eth-solo-staking-step-by-step-guide/. Additionally, validators are
pseudonymous and randomly selected, and transactors cannot select particular validators
that have been identified or screened for sanctions risks. Ethereum.org, Proof-of-Stake
(POS) (accessed January 23, 2023), https://ethereum.org/en/developers/docs/consensus-
mechanisms/pos/.
103
On Ethereum, validators are paid “priority fees,” which are theoretically voluntary,
but it is unlikely a validator would validate a transaction if it were not paid to do so.
Ethereum.org, Gas and Fees (accessed January 23, 2023),
https://ethereum.org/en/developers/docs/gas/.
104
See supra notes 102–103.
- 33 -
processing fees, it is risking making payments that support illicit finance or terrorist
activity or to a prohibited jurisdiction or entity.
Custodia’s Plans for BSA and OFAC Compliance. Custodia is in the process of
developing policies, procedures, and controls to manage ML/TF and OFAC sanctions
evasion risks for crypto-asset-related activities, including with respect to customer due
diligence, transaction monitoring, and sanctions screening, but as of the pre-membership
examination, the systems had not yet been sufficiently developed to allow for review.
Custodia has indicated that its AML and OFAC compliance programs would ultimately
be designed to meet the requirements in the Wyoming SPDI BSA/AML and OFAC
examination manual. 105 Among other things, these prospective compliance programs
would include a board of directors compliance committee to report and escalate risks to
the board; customer identification onboarding involving due diligence on purpose and
source of wealth; use of vendors to assist with automated customer screening and
transaction monitoring; 106 compliance staffing and resources including a Chief
105
Second AI Response, at 40; Third AI Response, at 36. The program would include
(i) the development and maintenance of comprehensive written policies and procedures
that are tailored to its business model; (ii) designation of a compliance officer who has
significant commercial bank BSA/AML compliance experience; (iii) ongoing training
and education; (iv) independent review and testing; and (v) customer due diligence. First
AI Response, at 43–44; Second AI Response, at 33–34.
106
Second AI Response, at 33–34, 39–41. For screening transactions for sanctions
compliance, Custodia has indicated that it will (i) incorporate geolocation tools and IP
blocking controls; (ii) implement screening of wallet addresses against those specifically
listed by OFAC sanctions; (iii) implement screening of other IP or wallet addresses
acquired in the course of the transaction; and (iv) employ blockchain analytics tools to
identify and mitigate sanctions risks. Id. Custodia contends that with the help of vendors
it will be able, through the use of open-source and proprietary data, to (i) develop a
- 34 -
Compliance Officer and a BSA/AML-specific analyst; an independent review of the
compliance program; and reports and metrics to inform senior management regarding
customer onboarding and transaction monitoring. 107
In addition, Custodia proposes a phased roll-out of services and would initially
limit its offerings to certain customers and certain activities; for example, it does not
intend to accept non-U.S. businesses and natural persons to be customers at the outset, in
order to allow for build-out of a program commensurate with associated risks. 108
Furthermore, Custodia seeks to rely on blockchain analytics firms 109 and other vendors to
mitigate any gaps in traditional AML/OFAC controls resulting from the characteristics of
sanctions risk profile of counterparties, (ii) employ a list of high-risk or “blacklisted”
wallet addresses, (iii) trace the transaction history of particular crypto-assets, and
(iv) screen wallet addresses against both OFAC’s list of sanctioned addresses and a
proprietary list of addresses associated with sanctioned persons or sanctioned
jurisdictions built through the use of blockchain analytics. Id., at 33–34.
107
Id., at 34–35.
108
Second AI Response, at 37. While Custodia would not issue Avits directly to non-
U.S. customers or natural persons initially, such persons could purchase and hold Avits
on the secondary market during this phased roll-out period. Given this feature, the
proposed timeline for a phased roll-out, and the importance of these activities for
Custodia’s business model, in reviewing the application, the Board considered the entire
proposal including later stages of the roll-out. Indeed, Custodia proposes to begin
offering some of its other services to non-U.S. persons within . See First AI
Response, at 44.
109
FinCEN, in discussing the capabilities of blockchain analytics firms, stated “[w]hile
[blockchain analysis] techniques can be used to combat illicit finance, they are not a
panacea. Blockchain analysis can be rendered less effective by a number of factors,
including the scale of a blockchain network, the extent of peer-to-peer activity (i.e.,
transactions between unhosted wallets), the use of anonymizing technologies to obscure
transaction information, and a lack of information concerning the identity of transferors
and recipients in particular transactions.” See FinCEN Proposed Requirements, at 83844.
- 35 -
crypto-assets. 110 Custodia has asserted that it will have the ability to freeze and seize
Avits in response to law enforcement requests and when an Avit is held by a
“blacklisted” wallet. 111
Analysis of Custodia’s Existing Compliance Programs. As of the time of the
pre-membership examination, Custodia had not demonstrated that it could satisfactorily
manage the significant ML/TF risks presented by its proposed business plan. The pre-
membership examination was limited to Custodia’s proposed core banking activities and
did not include review of the more challenging proposed crypto-asset-related operations,
which were not ready to be reviewed. Nevertheless, examiners identified significant gaps
that indicated the bank has not yet established adequate AML and OFAC compliance
110
Second AI Response, at 40. Custodia would implement
automated sanctions blacklisting on Ethereum. Third AI Response, at 3, 35–36, 53–55.
Custodia asserts that on Liquid, it “will have the ability to screen Avit transactions on
Liquid against its consolidated blacklist.” Third AI Response, at 55. Custodia
represented that it would “monitor one ‘hop’ in either direction before or after a digital
asset hits or leaves Custodia.” First AI Response, at 46. However, Custodia stated that
“[w]hile Custodia will have the ability to monitor transactions across the blockchain(s), it
will do so on a risk-based basis to ensure that customers of Custodia are not engaging in
money laundering or other suspicious activity either downstream or upstream of the
transaction(s) directly involving Custodia.” Id. With respect to Liquid, Custodia states
that it “is working to set up [surveillance] capabilities,
allowing it to meet all of its [BSA/OFAC] requirements,” including the identification of
individuals sanctioned by OFAC. Second AI Response, at 10.
111
First AI Response, at 25; Third AI Response, at 52–55. Custodia states it would
develop and maintain a blacklist of wallets it “has deemed to be suspicious, whether
through
.” Third AI Response, at 53.
According to Custodia, Avits on both blockchains
would allow for freezing and seizing of the token. Id., at 52–55.
- 36 -
programs even for its core banking activities. As of the examination, Custodia had not
yet developed or implemented a comprehensive AML/OFAC risk assessment that
provided sufficient detail to guide the development of adequate, risk-based AML and
OFAC compliance programs. 112 This deficiency led or contributed to numerous
additional compliance-related inadequacies noted by the examiners. For example,
examiners found that Custodia’s policies and procedures were insufficient, oversight and
implementation of key IT systems were lacking, and training resources were deficient
and not tailored to Custodia’s risk profile.
Examiners further determined that the transaction monitoring systems for high-
risk customers are insufficient to support timely identification and reporting of suspicious
transactions and that the transaction monitoring processes are not risk-based or aligned
with Custodia’s planned operations and risk profile. Finally, examiners found that
Custodia’s policies, procedures, and processes did not allow for timely identification and
reporting of suspicious activity. Setting aside consideration of Custodia’s crypto-asset-
related activities, discussed below, the Board has previously made clear that proposals
112
See generally Letter from Jeffrey Imgarten to Board of Directors of Custodia Bank,
Inc., dated October 21, 2022. Subsequent to the examination, Custodia provided an
updated ML/TF and sanctions risk assessment. In addition, Custodia has indicated that it
is actively working to address the other issues identified in connection with the
examination and has provided a remediation plan. While these efforts have not yet been
evaluated by the Reserve Bank examiners, and Custodia believes that the issues can be
remediated by , given the fundamental problems identified during the
examination and the narrow focus of the exam, the anticipated timeline for potential
remediation and verification of Custodia’s AML/OFAC compliance program is uncertain.
This is particularly the case in light of the lack of development of systems, controls,
policies and procedures with respect to Custodia’s proposed crypto-asset-related
activities generally.
- 37 -
from financial institutions with less than satisfactory AML and OFAC compliance
programs face substantial barriers to approval, in part because resolving such concerns
can take a significant amount of time. 113
Analysis of Compliance with Respect to Crypto-Asset-Related Activities. The
examiner findings on Custodia’s compliance deficiencies with respect to its core banking
activities suggest that Custodia is unlikely to be able to effectively comply with the
BSA/OFAC requirements for its proposed, more complex, higher-risk crypto-asset-
related activities. Custodia has acknowledged that it “faces the risk that its products may
be used for money laundering activity or activity that violates U.S. sanctions” particularly
in light of the fact that users would have the “ability . . . to make or accept transactions to
or from non-Custodia wallets, which would not have undergone an onboarding process
with Custodia.” 114 Further, Custodia has acknowledged that “due to the nature of
pseudonymous blockchains in which Custodia will enable customers to transact, the
113
See supra note 87.
114
Second AI Response, at 37.
. First AI Response, at 3. For instance, Kraken and Bittrex were fined
for OFAC violations. See Department of the Treasury, OFAC Settles with Virtual
Currency Exchange Kraken for $362,158.70 Related to Apparent Violations of the
Iranian Transactions and Sanctions Regulations (November 28, 2022); Department of the
Treasury, OFAC Settles with Bittrex, Inc. for $24,280,829.20 Related to Apparent
Violations of Multiple Sanctions Programs (October 11, 2022). In addition, in April
2022, the Office of the Comptroller of the Currency (“OCC”) entered into a consent order
with Anchorage Digital Bank, NA, after determining that Anchorage failed to adopt and
implement a compliance program that adequately covers the required BSA requirements.
See In the Matter of Anchorage Digital Bank, National Association, OCC Consent Order
2022-010 (April 21, 2022).
- 38 -
name of a non-customer involved in a transaction may not always be available.” 115
Custodia indicates that noncustomers will be able to hold Avits and redeem Avits without
undergoing due diligence required for customer onboarding. 116
Additionally, Custodia has indicated that it does not believe that certain
BSA/OFAC requirements would apply to certain elements of its proposed activities. For
example, Custodia stated it “has no BSA requirements for transfers of Avits between
non-customers.” 117 More specifically, Custodia contends that it would not be required to
file Suspicious Activity Reports (“SARs”) involving transactions between noncustomer
holders of Avits. 118 In addition, Custodia does not believe it should be obligated to
115
Second AI Response, at 38. Identifying noncustomer holders of Avits would require
significant investigation (unless the wallet holder has previously and publicly been
identified), an expensive proposition not certain to actually identify the holder. See
FinCEN Proposed Requirements, at 83844. Custodia has indicated it would only conduct
risk-based due diligence of non-customers transacting in Avits under specific
circumstances. Second AI Response, at 38–40; First AI Response, 26–29.
116
First AI Response, at 44–45. Custodia asserts that it is not required to conduct
ongoing due diligence of noncustomers holding Avits, although it proposes to engage
voluntarily in some monitoring of suspicious activities. Third AI Response, at 33–39.
Custodia asserts that noncustomers will be subject to heightened compliance
requirements if they seek to redeem Avits, although it is unclear what those requirements
would be beyond
First AI Response, at 26–27; 44–45.
117
Third AI Response, at 38. Nevertheless, Custodia represents it would voluntarily
monitor transfers of Avits between noncustomers through
. Id. In many cases, it is unlikely Custodia will know or be able
to determine the identity of the transactors, a vital element of transaction monitoring for
suspicious activity. See FinCEN Proposed Requirements, at 83844 (noting that
Blockchain analysis can be rendered less effective by a number of factors).
118
Third AI Response, at 42. Custodia has also indicated that it does not believe Avits
should be treated as a negotiable instrument for BSA purposes, including for reporting of
transportation of currency/monetary instruments and recordkeeping with respect to
- 39 -
conduct ongoing due diligence of noncustomers holding Avits. 119 Finally, as discussed
above, Custodia asserts that payments of transaction processing fees to unknown persons
likewise fall outside BSA and OFAC regulatory requirements. 120 While these are issues
that neither FinCEN nor OFAC has specifically addressed and though Custodia has
offered to voluntarily monitor noncustomer transactions and file SARs, such issues
highlight the inherent risks and challenges associated with crypto-assets that need to be
mitigated to ensure this activity can be conducted in a safe and sound manner.
2. Proposed Management
In evaluating Custodia’s management, the Board has considered the competence,
experience, and integrity of the officers, directors, and principal shareholders of Custodia.
Insufficient banking experience is a commonly identified problem in membership
applications. Proposed directors and managers should have experience commensurate
transfer of funds, currency, and monetary instruments. Id., at 31–33. Nevertheless,
Custodia believes recordkeeping rules would apply, even if an Avit is not a negotiable
instrument, because it would still be a transfer of funds or credit. Id., at 32–33.
119
Id., at 33.
120
Custodia states it “is not aware of any way for it (or another submitter of transactions
on the Ethereum blockchain) to prevent payment of a [transaction processing fee] in
[e]ther to a sanctioned person acting as a validator pursuant to the Ethereum protocol,”
but argues such transactions are nevertheless permissible under certain OFAC guidance.
Id., at 17. Specifically, Custodia referenced OFAC guidance stating that sales of goods to
Iran would only be prohibited in instances where the seller had explicit knowledge or
reason to know the seller’s goods are intended for Iran. Id. (citing Office of Foreign
Assets Control, Guidance on Transshipments to Iran, Ref. 020722-IR-01 (July 22, 2002)).
With respect to Liquid, Custodia represents that transaction processing fees are paid to a
wallet controlled by Blockstream, an entity that contributes to the management of Liquid,
which holds the fees in part to pay for the operation of Liquid, including to pay
transaction fees on the Bitcoin blockchain. Id., at 44.
- 40 -
with the duties required for the position sought, taking into consideration the size and
complexity of the organization. The Board has discouraged proposals that involve
individuals with limited relevant banking or business experience for key management or
decision-making positions. 121
In the course of the pre-membership examination, Custodia provided detailed
information on the proposed management and leadership team. While Custodia’s board
is active and meets biweekly, the overall effectiveness of board and senior management
remains difficult to determine, as Custodia has yet to truly commence operations and the
Board is not sufficiently assured that Custodia’s proposed management team could
conduct its proposed activities in a safe and sound manner based on the information
currently available. The depth of banking experience and bank-specific risk management
experience among the board of directors and management team is limited, and Custodia’s
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’s proposed day-one activities. 122
121
SR Letter 14-2 notes that a common managerial issue that has made approval by the
Federal Reserve of applications problematic is insufficient banking experience.
Specifically, the letter indicates that individuals with extensive large bank or investment
banking experience may not necessarily have the appropriate experience to manage
community or regional banks.
122
See, e.g., Custodia Bank, Inc., Custodia Team’s Experience in Traditional Banking
(July 20, 2022) (Attachment to Email Correspondence from Caitlin Long to Ross Crouch
et al. dated August 3, 2022).
- 41 -
Further, there has been significant turnover within management as the
organization has worked through product, systems, and risk management development. 123
While Custodia has made recent staffing additions and proposed staffing increases, 124 it is
unclear if these changes will address and remediate the identified gaps in the risk
management practices.
3. Risk-Management Systems and Operations
Custodia’s pre-membership examination raised significant questions about
management’s ability to conduct Custodia’s intended business in a safe and sound
manner. 125 Such an examination is particularly insightful in relation to a de novo charter
123
Compare Initial Business Plan, at 76, with Custodia Bank, Inc., Organizational Chart
(July 14, 2022) (Attachment to Email Correspondence from Caitlin Long to Ross Crouch
et al. dated August 3, 2022).
124
Since the pre-membership examination, Custodia has hired a Senior Vice President of
Risk with supervisory and traditional banking senior risk management experience, and a
dedicated BSA Officer. Custodia also recently posted three risk management positions to
further expand traditional banking experience, which remained open as of December 20,
2022. Letter from Caitlin Long to Ross Crouch dated December 20, 2022.
125
The Board, FDIC, and OCC have issued joint guidelines identifying safe and sound
banking practices that would typically be expected or required of an operating state
member bank. 12 CFR 208.3(d)(1); part 208, Appendix D-1. The guidelines indicate
that banks should have an internal audit system, internal controls, and information
systems that are appropriate to the size of the institution and the nature and scope of its
activities to provide for an organizational structure that establishes clear lines of authority
and responsibility for monitoring adherence to established policies, effective risk
management, timely and accurate financial, operational, and regulatory reports, adequate
procedures to safeguard and manage assets, and compliance with applicable laws and
regulations. 12 CFR part 208, Appendix D-1.
- 42 -
because there is a lack of management track record to review. The pre-membership
examination focused only on core banking activities, because at the time of the
examination, Custodia had not yet developed its policies and procedures for crypto-asset-
related activities to the point where they were ready for review. Examiners found a wide
range of risk management systems and supporting policies and procedures to be
insufficient for a traditional commercial bank. Areas lacking in formal and properly
documented practices include IT and internal audit and controls, as well as
BSA/AML/OFAC compliance (as discussed above). The Board finds the deficiencies
identified in Custodia’s pre-membership examination to be significant.
Examiners noted significant gaps relative to Custodia’s development and
formalization of comprehensive IT-related policies, procedures, and standards; overall IT
risk management framework; vendor management; and business continuity planning. 126
Further, examiners noted that Custodia had outsourced the internal audit program to the
same firm conducting the annual external audit of its financial statements, indicating a
lack of independence between the audit functions. In addition, Custodia’s internal audit
policy did not address its oversight of the outsourced internal audit provider, ensure
126
See generally Letter from Jeffrey Imgarten to Board of Directors of Custodia Bank,
Inc., dated October 21, 2022. Subsequent to the pre-membership examination, Custodia
submitted updated business continuity planning documents and a cybersecurity risk
assessment. While these efforts have not yet been evaluated by the Reserve Bank
examiners, as noted above, given the fundamental issues and narrow focus of the
examination, an anticipated timeline for potential remediation and verification of the
remediation is uncertain. See supra note 112.
- 43 -
conformance with industry standards, describe the risk assessment methodology, or
define reporting standards and expectations.
Custodia also had not developed sufficient liquidity risk management policies and
procedures and lacked a contingency funding plan, liquidity risk management metrics,
and comprehensive liquidity policy guidance. While Custodia’s anticipated liquidity risk
would be low during its first three years of operation, long-run liquidity risk would
modestly increase as additional investment options become available. 127 Though
Custodia’s overall liquidity risk would remain low, a sufficient liquidity risk management
policy commensurate with its appropriate level of risk, including a contingency funding
plan, has not yet been developed.
Examiners also noted that policies and procedures related to planned crypto-asset-
related activities were in the early stages of development, and formalized risk
assessments for planned products and services were outdated at the time of review or had
not yet been completed. In light of this, examiners were unable to determine whether
Custodia’s overall policies and procedures were sufficiently tailored to Custodia’s unique
business model and planned activities. Consequently, examiners concluded that there
was insufficient information available at the time of the examination to fully evaluate
127
Custodia has acknowledged the volatility of deposits from crypto-asset-related
customers and proposes to mitigate associated risks by holding highly liquid reserves.
Initially, Custodia would hold reserves equal to at least 108 percent of customer deposits
in a Federal Reserve Bank master account, if one is granted. First AI Response, at 15–17.
However, after three years of operation, Custodia proposes to invest at least some of the
funds pertaining to customer deposits in Treasury securities with maturities of three
months or less and/or in reverse repurchase agreements on Treasury securities. Id.;
Investment Policy, at 1–3.
- 44 -
whether Custodia’s risk management systems and controls were adequate to enable it to
engage in the proposed crypto-asset-related activities in a safe and sound manner, or to
assess comprehensively the overall administration of these activities relative to the
factors the Board considers under the Federal Reserve Act and Regulation H.
Since the pre-membership examination, Custodia has provided a remediation plan
and related materials. Review of the plan and Custodia’s proposed timing for full
remediation suggests that an additional examination would be required at a later date. 128
However, the number and degree of shortcomings identified in the pre-membership
examination suggest that management’s experience is not commensurate with the firm’s
intended risk profile. A management team that struggled to set up an effective risk
management system for its core banking activities may not be well positioned to oversee
a number of highly risky activities in which no state member bank has engaged to date.
In addition, as noted in the recent Joint Statement on Crypto-Asset Risks to Banking
Organizations, based on the Board’s current understanding and experience to date,
issuing or holding as principal crypto-assets that are issued, stored, or transferred on an
128
Letter from Caitlin Long to Ross Crouch dated December 20, 2022. While several
milestone dates are described in the proposed remediation plan, Custodia would not
conclude its remediation efforts on outstanding risk management concerns until at least
. Custodia acknowledges that continued effort is necessary to fully remediate
the majority of the gaps identified in the pre-membership examination. At a minimum, a
targeted examination would be required to assess the adequacy of management's
remediation efforts given the breadth of detailed issues identified during the pre-
membership examination.
- 45 -
open, public, and/or decentralized network, or similar system is highly likely to be
inconsistent with safe and sound banking practices. 129
4. Resolution
The Board has also considered evidence regarding whether Custodia could be
safely and effectively resolved upon failure. 130 Under Wyoming Division of Banking
regulations, Custodia is required to submit a recovery and resolution plan to the state
banking commissioner within six months of commencing operations. 131 While Custodia
has not yet developed or submitted a resolution plan, it has indicated preliminarily that it
would likely rely upon a sale of assets and liabilities to
. 132 Alternatively, Custodia would
recommend selling its custody business to , and
its deposit business (which may include Avits) to
. 133 However, the very reason these
are identified as potential acquirers (their existing business with the
129
Board of Governors of the Federal Reserve System et al., Joint Statement on Crypto-
Asset Risks to Banking Organizations, at 2 (January 3, 2023) (“Joint Statement”).
130
Custodia represents that receivership would be “relatively straightforward, as its
business does not include complex assets or liabilities to resolve.” Second AI Response,
at 31. Custodia asserts that its resolution plan and Wyoming’s SPDI receivership rules
and crypto-asset custody laws are designed to keep crypto-assets under custody outside
an SPDI’s estate, which would ensure that customers “would not need to endure a
lengthy bankruptcy process before they obtain their property in the event of an SPDI
receivership.” Id., at 31–32.
131
Wyo. Admin. Code 21-2-20 § 4.
132
First AI Response, at 40.
133
Id., at 40–41.
- 46 -
crypto-asset sector) makes it likely that such proposed acquirers would be experiencing
stress at the same time and for the same reasons as Custodia. Indeed, certain banks
providing deposit and payment services to the crypto-asset industry have faced
significant stress in connection with similar stress in the crypto-asset sector. 134
Concerns about Custodia’s preliminary approach to resolution planning are further
heightened in view of the untested nature of Wyoming’s SPDI receivership regime.
Custodia represents that under Wyoming law, the state banking commissioner would act
as the receiver and resolution official in the event of insolvency. 135 Resolving complex
depository institutions is a highly complicated task, and the receivership of such
institutions is typically the responsibility of the FDIC. 136 In 1991, when Congress passed
FDICIA and made it possible for a deposit-taking state member bank to be outside the
134
See, e.g., Silvergate Capital Corporation, Form 8-K, Exhibit 99.1 (January 5, 2023)
(explaining that a “crisis of confidence” in the crypto-asset ecosystem caused an $8.1
billion decline in deposits from crypto-asset customers in the fourth quarter of 2022,
leading Silvergate Capital Corporation (“Silvergate”) to increase wholesale funding and
incur $718 million in losses on sales of debt securities to meet liquidity needs); see also
Signature Bank (“Signature”), Form 8-K, Exhibit 99.2 (January 17, 2022) (noting that
crypto-asset-related deposits declined $7.35 billion in the fourth quarter of 2022 and
$12.39 billion for the twelve months ended December 31, 2022, due to a “[p]lanned
[r]eduction in [crypto-asset-related deposits] and a [c]hallenging [c]ryptocurrency
[e]nvironment”).
135
First AI Response, at 39–41; Second AI Response, at 31–32; see also Initial Business
Plan, at 4; Wyo. Stat. § 13-12-126; Wyo. Admin. Code 21-2-20 §§ 4 and 6.
136
See 12 U.S.C. § 1821(c). In recognition of the unique complexities of resolving
deposit-taking organizations, depository institutions generally are not considered eligible
to become “debtors” for purposes of proceeding under the federal Bankruptcy Code. See
11 U.S.C. § 109(b), (d). While nondepository trust companies may be resolved outside
of FDIC receivership, trust assets are generally not part of the failed institution’s
bankruptcy estate, making such resolutions significantly different than those for
depository institutions.
- 47 -
reach of FDIC receivership, state member banks often conducted their business entirely
in one state and were typically prevented from branching across state lines. 137 Moreover,
without internet banking, bank branches were more limited in their ability to attract
deposits from far outside their locality. However, Custodia’s growth assumptions are
based on the judgment that “
” such that there would not be “
.” 138 In addition, Custodia has stated that it “will accept and
welcome international customers so long as they pass necessary due diligence
requirements” 139 as early as after commencing operation. 140
In addition to the foregoing concerns, Custodia acknowledges that several of its
products and services involve novel applications or interpretations of property or
137
See S. Rep. No. 103-240, at 4–12 (1994) (describing the history of geographic
constraints on banking); H.R. Rep. No. 103-448, at 19–21 (1994) (same). Interstate
branch banking by state member banks was restricted by the McFadden Act until this
prohibition was repealed by the Riegle-Neal Interstate Banking and Branching Efficiency
of 1994. See McFadden Act § 9, ch. 191, 44 Stat. 1224 (1927); Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994, Pub. L. No. 103-328, 108 Stat. 2338,
2339. While interstate banking was permissible under the McFadden Act for multibank
holding companies with state approval, most states did not permit interstate multibank
holding companies until the late 1980s. Allen N. Berger et al., The Transformation of the
U.S. Banking Industry: What a Long, Strange Trip It’s Been, 2 Brookings Papers on
Economic Activity 55, 188–89 (1995). Most states also imposed restrictions on intrastate
branching, with several banning it entirely. Id.
138
First AI Response, at 92.
139
Initial Business Plan, at 39.
140
First AI Response, at 44.
- 48 -
commercial law. 141 One novel product, Avits, could be held by individuals all over the
globe with whom Custodia has no customer relationship—and each holder would have a
claim to a liability on Custodia’s balance sheet. 142 Thus, the untested resolution process
could have nationwide or cross-border implications. Based on the foregoing, Custodia
has not provided sufficient evidence that it could be resolved in a safe or efficient
manner. Uncertainty regarding such an outcome could contribute to instability and run
risk at a time of stress for Custodia.
* * *
Based on the foregoing review and all the facts of record, the Board has
determined that the considerations relating to the managerial factor are so adverse as to
be sufficient grounds on their own for warranting denial of Custodia’s application.
B. Financial Considerations
In considering whether Custodia’s proposal is consistent with the financial factor,
the Board has reviewed Custodia’s business plan and financial projections to assess the
bank’s financial history and condition, future earnings prospects, capital adequacy, and
other financial indicators. 143 As a general matter, proposals have been viewed
141
See, e.g., Initial Business Plan, at 10–11, 52, 68, 116–19; Second AI Response, at 21–
23, 31–32; Third AI Response, at 22–32.
142
Further, Custodia has represented that it would not have policies and procedures to
resolve disputes regarding the ownership of individual Avits (such as to resolve disputes
between claimants to the same issued Avit) and has suggested that such disputes would
need to be resolved by courts. Third AI Response, at 28.
143
12 U.S.C. §§ 322, 329; 12 CFR 208.3(b)(1) and (2).
- 49 -
unfavorably if an applicant is (i) not in sound financial condition or (ii) has uncertain
future earnings prospects. 144
1. Financial History and Condition
Given that Custodia only recently started operations, there is very limited financial
history to assess. Although Custodia received its charter in 2020, it did not receive a
certificate to operate from the state until September 12, 2022. Custodia started operations
in October, but it has not yet offered services to customers. As of October 2022,
Custodia has raised total capital of $52.0 million, although approximately half of that
sum has been spent on formation expenses. The most recently provided pro forma
financial statements project total equity capital of $28.8 million and total assets of
$65.1 million (assuming a 2022 opening). Assets on the pro forma statements are almost
entirely balances due from banks, and liabilities are predominantly customer deposits.
Projected initial pro forma capital ratios would be 190.5 percent for common equity tier 1
capital, tier 1 capital, and total capital. The leverage capital ratio would be 66.4 percent.
Custodia has indicated that it would comply with the capital requirements for state
member banks under Regulation Q. 145
While Custodia appears to have sufficient capital and resources to sustain initial
operations, Custodia’s pro forma financial statements assume that it would be permitted
144
SR Letter 14-2, at 4, 6; 12 CFR 208.3(b)(2).
145
First AI Response, at 37. See also 12 CFR part 217. Banks applying for membership
must have capital stock and surplus adequate in relation to the character and condition of
assets, liabilities, and corporate responsibilities. 12 U.S.C. § 329.
- 50 -
to engage in several novel crypto-asset-related activities. Indeed, Custodia’s medium and
long term viability would be dependent on engaging in such activities and, as discussed
in part II.C below, the Board would prohibit Custodia from engaging in such activities, if
it were to approve Custodia’s membership application. 146 There is thus a possibility that
additional capital would be needed to sustain operations after start-up if aggressive
earnings projections are not met.
Based on the lack of operating history and the reliance on future activities that the
Board would prohibit at this time if the membership application were approved, as well
as all the facts of record, the Board cannot reach a conclusion regarding whether
Custodia’s financial history and present financial condition is consistent with the
financial factor.
2. Future Earnings Prospects
In assessing Custodia’s future earnings prospects, the Board has considered,
among other things, the proposed business plan in conjunction with the organization’s
current condition, economic environment, and other relevant factors. Based on the pre-
membership examination and the overall record, the Board believes that Custodia’s
business model is subject to substantial uncertainty and may ultimately not be viable.
Custodia’s financial projections show
. Management projects net income
of . , total capital is projected to
146
See infra part II.C.
- 51 -
, and total assets are estimated to
. Based upon the entirety of the application and the Board’s considerations as
set out in this Order, the assumptions underlying these projections do not appear to be
realistic—particularly given the activities limitations Custodia would be subject to if it
were admitted to membership. 147
Custodia’s business model focuses solely on servicing the crypto-asset industry
and depends heavily on fee revenue from the crypto-asset-related activities it will
conduct. 148 To the extent the activities may be conducted permissibly, demand for those
services (and, by extension, Custodia’s ability to generate fee revenue) will ultimately
turn on the overall health of, and level of activity in, crypto-asset markets. 149 The
institutional clients and individual customers that Custodia is targeting will only need the
147
Custodia provided additional support for crypto-asset-related assumptions underlying
its financial projections in a proposed plan to remediate examiners’ findings from the pre-
membership examination. Confidential Exhibit I to the Letter from Caitlin Long to Ross
Crouch dated December 20, 2022. However, the analysis provided is not specific to
Custodia’s business model, contains a number of arbitrary and/or unsupported
assumptions, and fails to acknowledge recent volatility in the crypto-asset market.
148
From provided revenue projections, estimated income from Avit issuance, custody,
and prime services—business lines likely directly attributable to crypto-asset-related
activity—would account for
. First AI Response, at 4.
149
Reserve Bank examiners noted that the fee-based income model could result in
volatile earnings streams and is highly dependent on market acceptance of Custodia’s
products, services, and proposed fee structure, as well as the market price of bitcoin and
ether. For example, the third quarter 2022 earnings of Coinbase, a crypto-asset custodian
and exchange, show its total net revenue was half that of the year prior, driven by a 66
percent decline in transaction revenue. See Coinbase, Form 10-Q (November 3, 2022);
Coinbase, Form 10-Q (November 10, 2021). Reserve Bank examiners also noted that,
while Custodia projects rapid revenue growth, operating expenses are projected to remain
relatively stable and that assumptions driving this scenario are not sufficiently supported.
- 52 -
bank’s services if crypto-assets are perceived as an attractive investment. Moreover,
given the importance of fee income from planned crypto-asset-related activities to
Custodia’s overall business plan and the concentration and interconnectedness of the
crypto-asset industry, potential run-related risks with respect to assets under custody
could impact the viability of Custodia via a significant and sudden reduction in fee-based
revenue. For that reason, Custodia’s fortunes are tied directly to those of the crypto-asset
markets.
The Board generally disfavors business plans that “result in a concentration of
assets, liabilities, product offerings, customers, revenues, geography, or business activity
without effective mitigants.” 150 A business plan that focuses on a narrow business
activity and depends on a limited number of key business partners carries significantly
greater risks than a business plan that employs broad diversification of activities and
counterparties. In the past, the Board has indicated that it expects banking organizations
with a narrow focus to address these increased risks with financial resources, managerial
systems, and expertise commensurate with that additional level of risk. 151
In that context, Custodia’s concentration in crypto-assets is particularly
troubling. 152 Crypto-asset markets have proven very volatile. 153 For example, bitcoin
150
SR Letter 14-2, at 6.
151
See Green Dot Corporation, supra note 8.
152
See Joint Statement, at 2 (noting significant safety and soundness concerns with
business models that are concentrated in crypto-asset-related activities or have
concentrated exposures to the crypto-asset sector).
153
See supra note 12.
- 53 -
and ether, the largest crypto-assets by market capitalization, have fallen in value by just
under 45 percent from the date on which Custodia submitted its application. 154
Furthermore, the turmoil in crypto-asset markets, starting in spring 2022, highlights the
significant interconnectedness between crypto-asset firms and the substantial risks of
contagion in this industry. 155
The May 2022 collapse of algorithmic stablecoin TerraUSD, the third largest
stablecoin at the time, reportedly imposed substantial losses on investors, such as Three
Arrows Capital. 156 Following the collapse of TerraUSD, crypto-asset market
participants—most notably Voyager and Celsius—reportedly experienced liquidity issues
from withdrawals or margin calls, as well as losses from depressed crypto-asset prices
and exposure to Three Arrows Capital and each other. 157 The Securities and Exchange
Commission and the Commodity Futures Trading Commission have alleged that
154
According to data from coinmarketcap.com, bitcoin fell approximately 44.2 percent
from an intraday high of $41,341.93 on August 5, 2021, to an intraday high of
$23,056.73 on January 22, 2023. Ether fell approximately 41.7 percent from an intraday
high of $2,840.43 on August 5, 2021, to an intraday high of $1,658.02 on January 22,
2023. These crypto-assets experienced significant volatility over this period, trading
between highs of $68,789.63 and $4,891.71 and lows of $15,599.05 and $896.11 for
bitcoin and ether, respectively.
155
See, e.g., FSOC Report, at 48–54.
156
Id., at 38–40, 48–54; Chapter 15 Petition for Recognition of a Foreign Proceeding, In
re Three Arrows Capital, Ltd. (Bankr. S.D.N.Y. July 1, 2022) (No. 22-10920).
157
FSOC Report, at 38–40; Declaration of Stephen Ehrlich, Chief Executive Officer of
the Debtors in Support of Chapter 11 Petitions and First Day Motion, In re Voyager
Digital Holdings, et al. (Bankr. S.D.N.Y. July 6, 2022) (No. 22-10943); Declaration of
Alex Mashinsky, Chief Executive Officer of Celsius Network LLC, in Support of
Chapter 11 Petitions and First Day Motions, In re Celsius Network LLC, et al., (Bankr.
S.D.N.Y. July 14, 2022) (No. 22-10964-MG).
- 54 -
Alameda Research, a hedge fund affiliated with FTX through common ownership, also
experienced margin calls, prompting FTX to increase its support of Alameda Research,
including by providing FTX customers’ funds for the repayment of its loans. 158 These
actions helped to precipitate FTX and approximately 100 affiliates, including Alameda
Research, filing for Chapter 11 bankruptcy protection in November 2022. 159 Such events
appear to have undermined confidence in the crypto-asset ecosystem. 160
Recent experience has demonstrated that banks serving the crypto-asset sector by
providing traditional deposit and payment services have been affected by the stress in the
sector, even without engaging in the range of activities that Custodia proposes to
158
See Complaint for Injunctive and Other Equitable Relief and for Civil Monetary
Penalties Under the Commodity Exchange Act and Commission Regulations, at 20–23,
Commodity Futures Trading Commission v. Samuel Bankman-Fried, et al. (S.D.N.Y.
December 13, 2022) (No. 1:22-cv-10503); Complaint, at 21, Securities and Exchange
Commission v. Samuel Bankman-Fried (December 13, 2022) (No. 22-cv-10501). FTX,
in June 2022, provided a revolving line of credit to BlockFi, which also filed for Chapter
11 bankruptcy protection shortly after FTX did so. Declaration of Mark A. Renzi in
Support of Chapter 11 Petitions and First-Day Motions, In re BlockFi Inc., et al. (Bankr.
D.N.J. November 28, 2022) (No. 22-19361-MBK).
159
See supra notes 157–158.
160
Suvashree Ghosh and Joanna Ossinger, Crypto’s Post-FTX Crisis is Laid Bare as
Trading Volumes Plummet by 50%, Bloomberg (December 16, 2022),
https://www.bloomberg.com/news/articles/2022-12-16/crypto-s-post-ftx-crisis-is-laid-
bare-as-trading-volumes-plummet-by-50.
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conduct. 161 Thus, Custodia’s dependence on the crypto-asset market performance casts
substantial doubt on its future earnings prospects. 162
Further, as set out in the Corporate Powers section below, if the Board were to
approve the membership application, it would prohibit Custodia from engaging in several
of the crypto-asset-related activities core to Custodia’s business model. 163 Without
interest income generated from lending products offered by traditional banks, the limited
array of core banking products Custodia proposes would not likely generate sufficient
standalone cash flow to sustain operations. Deposit offerings do not typically provide
income, and ACH and wire transactions and issuance of cashier’s checks are typically
ancillary services accompanying a wider suite of products and services, including
commercial lending. If Custodia is unable to engage in most or even some of these
crypto-asset-related activities, it would effectively prevent the bank from moving forward
161
See supra note 134 (describing difficulties faced by Silvergate following a “crisis of
confidence” in the crypto-asset ecosystem, and crypto-asset deposit outflows at Signature
in part related to “a [c]hallenging [c]ryptocurrency [e]nvironment”).
Initial Business
Plan, at 54.
Initial Business Plan, at 92.
162
The experience of Coinbase is instructive in this regard. Coinbase is a crypto-asset
platform that offers a variety of crypto-asset-related services. Coinbase’s business model
is analogous to Custodia’s insofar as it relies substantially on fee revenue from crypto-
asset-related services. See Coinbase Global, Inc., Form 10-Q (November 3, 2022).
Coinbase experienced substantial revenue declines in 2022. Coinbase notes this point
explicitly in its recent quarterly SEC filing: “A decline in the market price of [b]itcoin,
[e]ther[] and other crypto-assets has had and could in the future have an adverse effect on
our earnings, the carrying value of our crypto-assets, and our future cash flows. This may
also affect our liquidity and our ability to meet its ongoing obligations.” Id., at 71.
163
See infra part II.C.
- 56 -
with essential elements of its business plan, increasing the likelihood that the bank would
not be viable.
* * *
Based on the foregoing review and all the facts of record, the Board has
determined that the considerations relating to the financial factor are so adverse as to be
sufficient grounds on their own for warranting denial of Custodia’s application.
C. Corporate Powers Considerations
When reviewing applications for membership, the Board is required to consider
“whether or not the corporate powers to be exercised [by the applicant] are consistent
with the purposes of [the Federal Reserve] Act.” 164 Among the purposes of the Federal
Reserve Act is the establishment of a stable banking system and bank supervisory
framework in order to contribute to the stability of the United States economy. 165 In its
most recent cases, the Board has primarily considered whether the applicant’s activities
would be permissible under sections 9(13) and 9(20) of the Act, 166 which generally
restrict any activities and investments of state member banks that would be impermissible
164
12 U.S.C. § 322; see also 12 CFR 208.3(b)(4).
165
See, e.g., Federal Reserve Act, Pub. L. No. 63-43, 38 Stat. 251 (December 23, 1913)
(“An Act . . . to establish a more effective supervision of banking in the United States,
and for other purposes.”); S. Rep. No. 133, 63d Cong. 1st Sess., at 7 (1913) (“The chief
purpose of the [Federal Reserve Act] is to give stability to the commerce and industry of
the United States, prevent financial panics or financial stringencies; making available
effective commercial credit for individuals engaged in manufacturing, in commerce, in
finance, and in business to the extent of their just deserts; put an end to the pyramiding of
the bank reserves of the country and the use of such reserves for gambling purposes on
the stock exchange.”).
166
12 U.S.C. §§ 330 and 335.
- 57 -
for a national bank, and whether the applicant’s activities would pose safety and
soundness risks to the applicant. 167 This section discusses those matters, as well as
considerations related to the admission of an uninsured deposit-taking bank.
1. Evaluation of Corporate Powers to be Exercised in Combination
Custodia has proposed to engage in a crypto-asset-focused business that is unlike
that of any other state member bank. Some of Custodia’s proposed activities, including
providing traditional deposit and payments services to companies involved in the crypto-
asset sector and, to a limited degree, offering safekeeping services with respect to crypto-
assets, are currently conducted by other state member banks. However, the Board is not
aware of any state member bank holding bitcoin and ether as principal; issuing
instruments like Avits; facilitating the borrowing and lending of crypto-assets; or directly
engaging with customers to facilitate the buying and selling of crypto-assets—whether
adjacent to a custody business; as a broker, dealer, exchange; or otherwise. Indeed,
Custodia’s core banking business is projected to be a relatively small portion of its
overall business. 168
167
See, e.g., Warehouse Trust Company LLC, 96 Federal Reserve Bulletin B13 (2010);
ICE US Trust LLC, 95 Federal Reserve Bulletin B73 (2009). This is consistent with the
Board’s practice since 1915, when the Board announced it would consider whether an
applicant bank’s “charter provisions are consistent with the proper conduct of the
business of banking and with membership in the Federal reserve bank.” 1 Federal
Reserve Bulletin 147 (July 1, 1915).
168
See supra part I.A.
- 58 -
Custodia’s fundamental focus is to support investment in and trading of crypto-
assets by institutional and high-net-worth investors. 169 Crypto-assets are, however,
largely speculative instruments, the value of which is driven in large part by sentiment
and future expectations. 170 Further, the crypto-asset sector appears to experience a high
incidence of fraud and theft, 171 and heightened ML/TF risks as discussed above. 172 To
date, the volatility of the crypto-asset ecosystem 173 has not led to financial stability issues
in other sectors—largely because interconnections between the crypto-asset sector and
the traditional financial sector have been relatively limited. But Custodia is attempting to
make it easier for institutional investors to use the crypto-asset ecosystem, 174 which
would increase such connections.
There are many examples of lawmakers and policy-makers taking steps to separate
banks from speculative activities due to safety and soundness concerns. Congress has
169
Initial Business Plan, at 2.
170
FSOC Report, at 25–28.
171
See, e.g., Consumer Financial Protection Bureau, Complaint Bulletin: An Analysis of
Consumer Complaints related to Crypto-Assets (November 2022); Securities and
Exchange Commission, Order Disapproving a Proposed Rule Change, as Modified by
Amendment No. 1, to List and Trade Shares of Grayscale Bitcoin Trust under NYSE
Arca Rule 8.201-E (Commodity-Based Trust Shares) (June 29, 2022); Federal Trade
Commission, Consumer Protection Data Spotlight: Reports Show Scammers Cashing in
on Crypto Craze (June 2022).
172
See supra part II.A.1 for discussion of ML/TF risks of crypto-assets.
173
Total crypto-asset market capitalization has fluctuated significantly, from a high of
over $3 trillion in November 2021 to lows under $850 million in November and
December 2022. CoinGecko, Global Cryptocurrency Market Cap Charts (accessed
January 23, 2023), https://www.coingecko.com/en/global-charts.
174
Initial Business Plan, at 2.
- 59 -
prohibited banks from taking part in a wide range of securities activities under the
Banking Act of 1933 (commonly referred to as the “Glass-Steagall Act”). 175 Congress
again sought to prohibit banks and bank affiliates from engaging in speculation in 2010
by limiting proprietary trading under the Volcker Rule. 176 Further, Congress has
prohibited banks from dealing in lottery tickets or promoting lotteries, 177 which was
motivated by a desire to preserve “the inescapable responsibility of a bank to always be
both a symbol and example of stability and security in the community.” 178
Based on the foregoing, the Board does not believe that Custodia’s proposed
business would be in furtherance of a stable banking system and bank supervisory
framework, and approval of the application would therefore be inconsistent with the
purposes of the Federal Reserve Act.
2. Permissibility of Activities and Safety and Soundness Risks
In assessing whether to grant membership, the Board considers whether an
applicant’s proposed activities and investments are permissible under sections 9(13) and
9(20) of the Act, and whether the proposed activities pose safety and soundness risks. As
discussed in detail below, Custodia has not established that several of its proposed
175
12 U.S.C. §§ 24, 378(a)(1).
176
12 U.S.C. § 1851.
177
Pub. L. No. 90-203, 81 Stat. 608 (1967) (codified at 12 U.S.C. §§ 25a, 339, 1829a).
Congress reinforced this prohibition with a criminal statute, that enables the fining or
imprisonment of anyone that “knowingly” violates the prohibitions on banking
participation in lotteries. 18 U.S.C. § 1306.
178
S. Rep. No. 90-727, at 3 (1967). The Senate Committee Report for the bill indicated
that it is “entirely proper to protect the sound image of banking by prohibiting banks from
the open sale of the lottery tickets to the public.” Id., at 4.
- 60 -
activities are permissible for national banks or that its proposed activities can be
conducted in a safe and sound manner. If the Board were to approve Custodia’s
application for membership, it would exercise its discretion under section 9(13) of the
Act to limit Custodia to conducting as principal only those activities permissible for
national banks. Further, with respect to novel and unprecedented activities, the Board
would condition admission under section 9(1) of the Act 179 on Custodia conducting only
those activities for which it has demonstrated appropriate systems to monitor and control
the risks of such activities. Because Custodia’s business model relies on its ability to
conduct these activities, these limitations under section 9(13) of the Act and conditions
under section 9(1) of the Act would adversely impact Custodia’s viability in the medium
and long term, as discussed in part II.B.2 above.
Section 9(13) of the Act. Under section 9(13) of the Act, the Board “may limit the
activities” of a state member bank and its subsidiaries to those activities that are
permissible for a national bank in a manner consistent with section 24 of the Federal
Deposit Insurance Act (FDIA). 180 Section 24 of the FDIA generally prohibits insured
179
Section 9(1) of the Act authorizes the Board to approve membership applications
“subject to the provisions of [the Act] and to such conditions as [the Board] may
prescribe pursuant thereto.” 12 U.S.C § 321.
180
12 U.S.C. § 330 (as amended by FDICIA § 303(b), Pub. L. No. 102-242, 105 Stat.
2236, 2353 (1991)).
- 61 -
state banks from engaging as principal in any activity that is not permissible for national
banks, 181 unless specifically authorized by federal statute or the FDIC. 182
The Board generally believes that the same bank activity, presenting the same
risks, should be subject to the same regulatory framework, regardless of which agency
supervises the bank. 183 This principle of equal treatment helps to level the competitive
playing field among banks with different charters and different federal supervisors and to
mitigate the risks of regulatory arbitrage. In alignment with this principle, and as made
clear in a policy statement approved by the Board today, the Board generally presumes 184
181
The National Bank Act enumerates certain powers that national banks may exercise
and authorizes national banks to exercise “all such incidental powers as shall be
necessary to carry on the business of banking.” 12 U.S.C. § 24(Seventh). The OCC has
the authority to interpret provisions of the National Bank Act and is charged with the
“discretion to authorize activities beyond those specifically enumerated,” within
reasonable bounds. NationsBank of North Carolina, N.A. v. Variable Annuity Life Ins.
Co., 513 U.S. 251, 258 n.2 (1995). Section 7.1000 of the OCC’s regulations identifies
the criteria that the OCC uses to determine whether an activity is authorized as part of, or
incidental to, the business of banking under 12 U.S.C. § 24(Seventh). 12 CFR 7.1000. If
a national bank has not been authorized by federal law, including the National Bank Act,
to engage in an activity, then national banks are not permitted to engage in such activity.
182
12 U.S.C. § 1831a(a); 12 CFR part 362.
183
See, e.g., Nomination of Jerome H. Powell, of Maryland, to be Chairman of the
Board of Governors of the Federal Reserve System: Hearing Before the Committee on
Banking, Housing, and Urban Affairs, 117th Cong. 81 (2022) (responses to written
questions of Chairman Brown) (“It is vital that the United States maintain a strong
financial regulatory system that adheres to the principle of same activity, same risks,
same regulation for all financial activity, including novel asset classes such as
cryptoassets.”).
184
This presumption may be rebutted if there is a clear and compelling rationale for the
Board to allow the proposed deviation in regulatory treatment among federally
supervised banks, and the state member bank has robust plans for managing the risks of
the proposed activity in accordance with principles of safe and sound banking. See
Board of Governors of the Federal Reserve System, Policy Statement on Section 9(13) of
- 62 -
that it will exercise its discretion under section 9(13) of the Act to limit state member
banks and their subsidiaries to engaging as principal in only those activities that are
permissible for national banks—in each case, subject to the terms, conditions, and
limitations placed on national banks with respect to the activity—unless those activities
are permissible for state banks by federal statute or under part 362 of the FDIC’s
regulations.
Safety and Soundness Risks. Legal permissibility is a necessary, but not
sufficient, condition to establish that a state member bank may engage in a particular
activity. A state member bank must at all times conduct its business and exercise its
powers with due regard to safety and soundness. 185 For instance, a state member bank
should design and implement internal controls and information systems that are
appropriate to the nature, scope, and risks of its activities. 186 Further, a state member
bank must comply with conditions of membership prescribed by the Board under section
9(1) of the Act, 187 and applicable laws and regulations, including those related to
consumer compliance and anti-money laundering. With respect to any novel and
unprecedented activities, such as those associated with crypto-assets, it is particularly
important for a state member bank to have in place appropriate systems to monitor and
the Federal Reserve Act, at 5–6 (January 26, 2023) (“Policy Statement”) (to be codified
at 12 CFR 208.112(d)).
185
12 CFR 208.3(d)(1).
186
12 CFR 208, appendix D-1.
187
12 U.S.C §§ 321; 1818(b), (e)(1)(A)(i)(III), (i)(2)(A)(iii); 12 CFR 208.3(d)(3).
- 63 -
control risks, including liquidity, credit, market, operational (including cybersecurity and
use of third parties), and compliance risks (including compliance with BSA and OFAC
requirements to reduce the risk of illicit financial activity).
a. Crypto-Asset Custody: Holding Bitcoin and Ether as Principal
Custodia has proposed to provide custody services for crypto-assets, which it
contends is permissible for national banks under OCC Interpretive Letter 1170. 188
However, Custodia asserts that, as part of this activity, it must hold a small amount of
bitcoin and ether in a principal capacity in order to pay customers’ transaction fees and
comply with Wyoming law. 189 Custodia also stated that it “has evaluated alternative
approaches to holding digital assets [as principal] for transaction fees and has not
identified an alternative approach that would allow it to serve customers efficiently and
without creating unnecessary risk.” 190
National Bank Permissibility. 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. 191 To support the
188
First AI Response, at 10 (“In an interpretive letter issued in 2020, the OCC confirmed
that a national bank ‘may provide [ ] cryptocurrency custody services on behalf of
customers, including by holding the unique cryptographic keys associated with
cryptocurrency.’”) (citing OCC Interpretive Letter No. 1170 (2020)).
189
See supra notes 47–49.
190
Second AI Response, at 24.
191
To date, the OCC has not made a determination addressing the permissibility of a
national bank holding crypto-assets as principal, other than “stablecoins” to facilitate
payments subject to the conditions of OCC Interpretive Letter 1179. OCC Interpretive
Letter No. 1174 (January 4, 2021) (“Interpretive Letter 1174”); OCC Interpretive Letter
- 64 -
permissibility of such holdings, Custodia cites other instances where the OCC has
specifically permitted banks to conduct activities that were otherwise impermissible in
limited circumstances. 192 Custodia views these precedents as evidence of a universal
authority to conduct a small amount of impermissible activities if the permitted activity
would otherwise be “infeasible, burdensome or less advantageous” without the
No. 1179 (November 18, 2021) (“Interpretive Letter 1179”). The OCC has required a
national bank to divest crypto-assets held as principal that it acquired through a merger
with a state bank. Specifically, the OCC conditioned its recent approval of the merger
between Flagstar Bank, FSB and New York Community Bank into Flagstar Bank,
National Association on the divestiture of holdings of “Hash,” a crypto-asset, after a
conformance period, as well as a commitment not to increase holdings of any crypto-
related asset or token “unless and until the OCC determines that . . . Hash or other crypto-
related holdings are permissible for a national bank.” OCC Conditional Approval Letter
No. 1299, at 9 (October 27, 2022).
192
Exhibit G to the Third AI Response. Custodia’s cited examples include a conditional
approval permitting a national bank’s operating subsidiary to “hold for limited periods of
time limited interest in certain private investment funds for which it serves as investment
manager,” OCC Conditional Approval No. 578 (February 27, 2003); a conditional
approval permitting a national bank’s operating subsidiary to own a general partnership
interest in a partnership if such interest enables it to act as investment manager for a fund
that, in practice, requires the manager to take an equity interest, id.; an interpretive letter
indicating that a national bank may become an inadvertent principal in a riskless principal
transaction because of the failure of the transaction, OCC Interpretive Letter No. 371
(June 13, 1986); ownership of shares in an insurance company that provided life
insurance to a national bank’s directors and officers following the insurance company’s
conversion from mutual to stock form, OCC Interpretive Letter No. 901 (June 29, 2000);
and ownership of limited partnership interests in connection with holding and reselling
transferrable state tax credits and natural gas leasing, OCC Corporate Decision No. 2006-
06 (July 12, 2006) and OCC Corporate Decision No. 98-18 (March 23, 1998).
- 65 -
impermissible activity. 193 But the Board believes these precedents recognize limited
authority to conduct carefully defined activities. 194
Because the Board has not identified authority to support Custodia’s contention
that national banks are permitted to hold bitcoin and ether as principal incidental to
permissible activities, and state banks have not been expressly permitted to do so by
federal statute or part 362 of the FDIC’s regulations, the Board would presumptively
prohibit state member banks from holding such assets as principal. 195
Safety and Soundness. The Board’s presumptive application of section 9(13) is
bolstered in this instance by the Board’s significant safety and soundness concerns with
respect to the activity. 196 The FSOC has observed that, in the absence of a fundamental
economic use case, the value of most crypto-assets is driven largely by sentiment and
future expectations, and not by cash flows from providing goods or services outside the
crypto-asset ecosystem. 197 This prevents firms that hold crypto-assets from engaging in
193
Exhibit G to the Third AI Response.
194
Further, Custodia cites instances when the Board found that certain activities are
permissible in limited circumstances in connection with a permissible activity under the
BHC Act. Id. In addition to not being legally relevant to bank-level permissibility,
decisions made by the Board in such contexts do not implicate the competitive parity
considerations applicable with respect to bank activities supervised by various regulators.
195
See Policy Statement, at 8.
196
As noted in the recent Joint Statement, based on the agencies’ current understanding
and experience to date, the agencies believe that holding as principal crypto-assets that
are issued, stored, or transferred on an open, public, and/or decentralized network, or
similar system is highly likely to be inconsistent with safe and sound banking practices.
Joint Statement, at 2.
197
FSOC Report, at 27; see also id., 23–28.
- 66 -
prudent risk management based on the underlying value of most crypto-assets, their
anticipated discounted cash flows, or the historic behavior of the relevant markets.
Moreover, the crypto-asset sector—which is globally dispersed—is largely unregulated
or non-compliant with regulation from a market-conduct perspective, and issuers are
often not subject to or not compliant with disclosure and accounting requirements. This
opacity may make it difficult or impossible to assess market and counterparty exposure
risks. Further, engagement in crypto-asset transactions can present significant illicit
finance risks, in part due to the pseudonymity of transactors and validators. 198 Finally,
crypto-assets may involve significant cybersecurity risks—especially in comparison to
traditional asset classes.
If the Board were to approve Custodia’s application, based on the foregoing and
all the facts of record, it would exercise its discretion under section 9(13) of the Act, and
impose a condition under section 9(1) of the Act, to prohibit Custodia from holding
bitcoin and ether as principal. The inability to conduct such activity may adversely affect
Custodia’s future earnings prospects as a state member bank.
b. Issuance of Avits
Custodia describes an Avit—a proposed token that would be issued on two
blockchains 199—as a “transferable record” for purposes of the Uniform Electronic
Transfers Act; a negotiable instrument for purposes of Article 3 of the Uniform
198
See supra part II.A.1.
199
See supra part I.A.3 for additional details regarding Custodia’s plans to issue and
redeem Avits.
- 67 -
Commercial Code; an electronic promissory note; 200 and a deposit representing the digital
equivalent of a cashier’s check for purposes of banking and securities law. 201 Avits, as
described above, would be circulating tokens that could be transferred indefinitely to an
unlimited number of successive holders before redemption—if they are ever redeemed. 202
200
Custodia likens an Avit to a “promissory note” for purposes of commercial law, but
has declined to conduct an analysis of whether an Avit would be a “note” under the
Securities Act of 1933 and the Securities Exchange Act of 1934 (the “federal securities
laws”), including Reves v. Ernst & Young, 494 U.S. 56, 66–67 (1990) (“Reves”), which
sets out a four-part framework to determine if a “note” is a security. Second AI Response
at 17. Custodia has asserted that “[f]rom a securities law perspective,” Avits are “bank
deposit[s]” and more appropriately evaluated exclusively under Marine Bank v. Weaver,
455 U.S. 551 (1982) (finding that certificates of deposit issued by an insured depository
institution were not securities). Second AI Response, at 17.
The Board does not take a position on how to evaluate the legitimacy of
Custodia’s interpretations regarding the federal securities laws. The Board notes,
however, that, with certain exceptions, under section 21(a)(1) of the Glass-Steagall Act,
an entity engaged in the business of issuing securities may not also be in the business of
receiving deposits. 12 U.S.C. § 378(a)(1). In interpreting this provision in Investment
Co. Institute v. Camp, the Supreme Court indicated that there is nothing in the provision
to suggest “a narrow reading” of the term “securities.” 401 U.S. 617, 635 (1971). The
Board has not reached a conclusion on this issue, but does not believe that a finding
regarding whether Avits would be securities under the Glass-Steagall Act is necessary in
light of the multiple, independent bases for denial of Custodia’s application established
herein.
201
First AI Response, at 8–9.
202
Further, the Avit is designed to be used by customers in a range of use cases. See
Second AI Response, at 14 (“A key benefit of Custodia issuing Avits on permissionless
blockchains is that Custodia’s customers will be able to build applications using Avit to
solve their particular business problems without requiring permission from Custodia to
do so, as would be the case with permissioned systems. This means Custodia’s
customers can take advantage of the widespread and interoperable infrastructure built
around permissionless systems to speed the development of their own software, improve
the functionality and reduce the cost.”).
- 68 -
The cash deposited by the initial holder of Avits would be held in a master account at the
Reserve Bank, if such account is granted. 203
National Bank Permissibility. The permissibility of the issuance of “stablecoins”
for national banks is subject to OCC Interpretive Letters 1174 and 1179, 204 including the
conditions set out therein. 205 The Board believes that Avits should be viewed as
“stablecoins” for purposes of assessing permissibility.
OCC Interpretive Letters 1174 and 1179 specifically permit a national bank to
issue “stablecoins” to facilitate payments, provided that the bank can demonstrate, to the
satisfaction of its supervisory office, that it has controls in place to conduct the activity in
a safe and sound manner. 206 In determining whether such controls are adequate,
203
See supra note 58.
204
Interpretive Letter 1174, at 9; Interpretive Letter 1179.
205
Custodia argues that, aside from Interpretive Letters 1174 and 1179, issuing and
redeeming Avits would be permissible for a national bank under the application of the
OCC’s Transparency Doctrine (12 CFR 7.5002(a)) to cashier’s checks. While it is true
that both cashier’s checks and Avits would represent deposits and could be held by
unknown persons, the instruments have different functions. Cashier’s checks are
designed to remove counterparty risk from a discrete payment transaction made in a
specific denomination. While a single cashier’s check can theoretically be transferred
more than once before it is returned to the bank, the logistics of physical transfer and
issuance in a particular amount prevent the formation of a significant secondary market
for cashier’s checks and prevent their use in a widespread way in secondary markets as a
settlement asset. In contrast, Avits are designed to be actively traded on global, virtual
secondary markets, including through centralized and decentralized exchanges, on an
indefinite basis. The ease of transacting in the instrument on a peer-to-peer basis or
through exchanges—and, more significantly, the exit liquidity provided by the secondary
markets—fundamentally distinguish Avits from cashier’s checks.
206
The OCC also notes that “stablecoins” may be securities, depending on their
structure, and that a bank’s issuance of a “stablecoin” must comply with all securities
laws and regulations, if applicable. Interpretive Letter 1174, at 6.
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Interpretive Letter 1179 states that supervisors will evaluate whether there are “adequate
systems in place to identify, measure, monitor, and control the risks of [a bank’s]
activities, including the ability to do so on an ongoing basis.” 207
Custodia has not been able to demonstrate that it can implement Avits in a safe
and sound manner because, at the time of the pre-membership examination, it had not yet
developed its risk management and control framework for the product. The Board does
not believe it would be permissible for Custodia to issue Avits at this time under the
terms and conditions established by the OCC, and such issuance is not specifically
permitted under federal statute or part 362 of the FDIC’s regulations. Therefore, the
Board would presumptively prohibit Custodia from issuing instruments like Avits until
such time as Custodia is able to demonstrate that it has controls in place to conduct the
activity in a safe and sound manner.
Safety and Soundness. The Board’s presumptive application of section 9(13) of
the Act is bolstered in this instance because the Board has broader concerns about
proposals to issue a token that represents a dollar deposit and circulates indefinitely on an
open, decentralized, or similar network where (i) persons unknown to the issuing bank
can hold the asset; and (ii) neither the bank nor its contracted vendors have control over
the governance and policies of the network, including, for example, consensus
207
Interpretive Letter 1179, at 4.
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mechanisms for processing transactions. 208 The Board’s preliminary concerns with Avits
include the following:
Illicit Finance Risks. OCC Interpretive Letter 1174 states that stablecoin
arrangements “should have the capability to obtain and verify the identity of all
transacting parties, including for those using unhosted wallets.” 209 Custodia’s proposal
for issuing and redeeming Avits does not meet this expectation. The first party that
receives Avits from Custodia and the party that attempts to redeem Avits with Custodia
would be known to the bank. But any other person or entity, anywhere in the world,
would be able to acquire or transfer Avits in the secondary markets without being known
to Custodia, so long as the wallet to which the transfer is made has not been blacklisted
due to sanctions concerns. 210 Further, due to the use of Ethereum, both Custodia and
holders of Avits will pay transaction processing fees to unknown transaction
validators. 211
Operational Risks. Through the use of blockchains not controlled by the bank or
its contracted vendors, operational activities—like processing transactions made in
208
Cf. Joint Statement, at 2 (“Based on the agencies’ current understanding and
experience to date, the agencies believe that issuing or holding as principal crypto-assets
that are issued, stored, or transferred on an open, public, and/or decentralized network, or
similar system is highly likely to be inconsistent with safe and sound banking
practices.”).
209
Interpretive Letter 1174, at 4 (quoting President’s Working Group on Financial
Markets, Statement on Key Regulatory and Supervisory Issues Relevant to Certain
Stablecoins, at 3 (December 23, 2020)).
210
See supra notes 110, 111.
211
See supra notes 102, 103; see also Third AI Response, at 17.
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Avits—and the governance of such activities would be outsourced to unknown third
parties. 212 Custodia would have little ability to hold validators or governance bodies
accountable for activity that may adversely affect the bank or its customers. 213
Cybersecurity Risks. Blockchain networks that are not controlled by a bank or its
contracted vendors present significant cybersecurity vulnerabilities. For example, threat
actors could maliciously access private keys that provide access to Avits held by known
or unknown persons. Additionally, threat actors could potentially compromise the smart
contract used to issue Avits and the underlying infrastructure of the blockchain,
particularly a network relying on a smaller number of validators. 214
Risks Related to Runs. On both Ethereum and Liquid, the public is able to see
tokens moving from one wallet to another, including as they are issued and redeemed. 215
212
Ethereum relies upon pseudonymous nodes to validate transactions, as opposed to
contracted third-party service providers. See supra note 102.
213
With respect to Ethereum, Custodia would have no contractual or other relationship
with Ethereum stakers involved in governance of the blockchain. With respect to Liquid,
Custodia states that
. Third AI Response, at
45–46; see also Second AI Response, at 8–9. Governance of Liquid is managed by the
Liquid Federation, a group of more than sixty crypto-asset companies. Second AI
Response, at 9. Custodia states that Liquid “
.” Third AI Response, at 44; see also id., at 61–62. The
Liquid Federation selects a small number of its members to operate validator nodes and
manages oversight of the Liquid network. Id.
214
Id., at 59–60, 62–67; Second AI Response, at 10; see also Mell and Yaga, supra note
75, at 27–29.
215
See, e.g., Blockstream, Liquid Explorer (accessed January 23, 2023),
https://blockstream.info/liquid/; Etherscan, Ethereum (ETH) Blockchain Explorer
(accessed January 23, 2023) https://etherscan.io/. On Liquid, the type of token and
amount are not visible to the public; however, senders, receivers, and the number of
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Therefore, the public would know when Avits are being redeemed in high or higher-than-
usual quantities. 216 This redemption transaction visibility could potentially increase the
likelihood of a run on Custodia’s Avits, other deposit liabilities, or custodied assets
(which could affect its fee revenue). While Custodia has said it will manage liquidity
risks by keeping all the dollars backing Avits in a master account at the Federal Reserve,
if such account is granted, runs on any bank or financial intermediary have been
documented to lead to panic and contagion that spreads to other banks and financial
intermediaries. 217
Consumer Risks. Avits would function much like other dollar-denominated tokens
issued on public blockchains—they could be traded on largely unregulated or
transactions are visible. Blockstream, How Does Liquid Keep My Transaction Data
Confidential? (accessed January 23, 2023), https://help.blockstream.com/hc/en-
us/articles/900001390743-How-does-Liquid-keep-my-transaction-data-confidential-.
216
See Krisztian Sandor, Tether Sees New Wave of Redemptions as Fear of Market
Contagion Spreads, CoinDesk (June 15, 2022), https://coindesk.com/markets/2022/06/15/
tether-sees-new-wave-of-redemptions-as-fear-of-market-contagion-spreads/; see also
Krisztian Sandor, Crypto Exchange Gemini Suffers $485M Rush of Outflows Amid
Contagion Fears, CoinDesk (November 16, 2022), https://coindesk.com/markets/2022/
11/16/crypto-exchange-gemini-suffers-485m-rush-of-outflows-amid-contagion-fears/.
217
See, e.g., Charles W. Calomiris et al., Interbank Connections, Contagion, and Bank
Distress in the Great Depression 51 Journal of Financial Intermediation 1 (July 2022);
Erik Heitfield et al., Contagion During the Initial Banking Panic of the Great Depression
NBER Working Paper Series (2017); Daron Acemoglu et al., Systemic Risk and Stability
in Financial Networks 105 Am. Econ. Rev. 564 (2015); Hal S. Scott, Connectedness and
Contagion 5–12 (2016); Gary Gorton and Andrew Metrick, Getting Up to Speed on the
Financial Crisis: A One-Weekend-Reader’s Guide, 50 Journal of Economic Literature
128 (2012); Ted Temzelides, Are Bank Runs Contagious? Federal Reserve Bank of
Philadelphia Business Review (November/December 1997). The PWG Stablecoin
Report noted the potential for a “run” to occur on a stablecoin, as well as the potential
implications of such a run for the broader financial system. See PWG Stablecoin Report,
at 12.
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noncompliant exchanges; lent on crypto-lending platforms; and invested in decentralized
finance protocols. 218 Each of these poses risks to Avit holders, 219 as demonstrated by the
bankruptcies of FTX, 220 Voyager, 221 Celsius, 222 Blockfi, 223 and the collapse of the
Terra/Luna protocol. 224 Avit holders engaging with these intermediaries and protocols
may not be in a position to understand the risks they are taking, given that such
intermediaries often do not comply with, or are not subject to, disclosure rules, conflicts-
of-interest standards, or prudential regulations.
Other Corporate Powers Considerations. In addition to these sufficient reasons,
the Board is concerned that the proposed activity could potentially undermine a number
of important public policies and mandates incorporated into the Federal Reserve Act and
other laws that the Board administers and implements. 225 For example, Congress charged
218
First AI Response, at 24–29.
219
While Custodia would not issue Avits directly to natural persons initially, such
persons could purchase and hold Avits on the secondary market, and Avits would
eventually be issued to high-net-worth individuals.
220
See Declaration of John J. Ray III in Support of Chapter 11 Petitions and First Day
Pleadings, In re FTX Trading Ltd., et al. (Bankr. D. Del. November 17, 2022) (No. 22-
11068-JTD); Angus Berwick, Exclusive: At Least $1 Billion of Client Deposits Missing
at Failed Crypto Firm FTX, Reuters (November 13, 2022), https://www.reuters.com/
markets/currencies/exclusive-least-1-billion-client-funds-missing-failed-crypto-firm-ftx-
sources-2022-11-12.
221
See Declaration of Stephen Ehrlich, supra note 157.
222
See Declaration of Alex Mashinsky, supra note 157.
223
See Declaration of Mark A. Renzi, supra note 158.
224
See FSOC Report, at 48–54.
225
For the reasons explained herein, concerns related to Custodia’s planned issuance of
Avits with reliance on deposits at the Federal Reserve directly calls into question
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the Federal Reserve with managing monetary policy “so as to promote effectively the
goals of maximum employment, stable prices, and moderate long-term interest rates,” 226
and has assigned the Federal Reserve various tools and responsibilities with respect to
maintaining financial stability. 227 Custodia’s plan to offer Avits and back them with
deposits at the Federal Reserve raises several concerns in this regard that would require
further consideration if Custodia were to be granted a master account by the Reserve
Bank. 228
The design of Avits could have implications for the Federal Reserve’s balance
sheet because the funds backing outstanding Avits would be held in a master account (if
granted), 229 which is essentially a deposit account with a Federal Reserve Bank. These
funds would be assets on Custodia’s balance sheet and liabilities on the Federal Reserve’s
balance sheet. Thus, Avit growth could generate particularly pronounced demand for
“whether . . . the corporate powers to be exercised [by Custodia] are consistent with the
purposes of [the Federal Reserve] Act.” 12 U.S.C. § 322.
226
12 U.S.C. § 225a.
227
See, e.g., 12 U.S.C. §§ 343, 347, 347c, 5321(b)(B)(1), 5322(a)(1); see also supra note
165.
228
As noted above at note 4, the decision to grant a master account with respect to a
given institution rests with the regional Federal Reserve Bank pursuant to the
discretionary deposit-taking authority vested in Federal Reserve Banks by Congress in
section 13 of the Act, 12 U.S.C. § 342. The Board’s Guidelines for Evaluating Account
and Services Requests, which provide guidance in this area, affirmed the Board’s long-
standing interpretation of the Act as granting such discretion to Reserve Banks. See
Guidelines for Evaluating Account and Services Requests, 87 Federal Register 51099
(August 19, 2022).
229
See supra note 58.
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Federal Reserve liabilities. Moreover, this demand could be volatile given Custodia’s
business model is tied to the highly volatile crypto-asset industry. 230
The combination of Federal Reserve membership and the perceived backing of
Avits by holdings of deposits in a master account at a Federal Reserve Bank could be
viewed by external parties as a form of implicit backing for Avits by the Federal
Reserve. 231 This could enable such a product to scale quickly and globally; it could
plausibly become a tool for persons around the world to access the stability of the U.S.
dollar instantly and anonymously. 232 Even if Custodia alone, at least initially, would not
have a significant demand for Federal Reserve liabilities, approving Custodia’s issuance
of instruments like Avits may set a precedent of allowing similar products at other banks
230
The Federal Reserve generally accommodates changes in the level or volatility of
demand for its liabilities through changes in the amount of assets (generally U.S.
Treasury securities) that it holds. As a result, large enough changes in the demand for
Federal Reserve liabilities generated by significant Avit growth could complicate the
Federal Reserve’s ability to manage the size of its balance sheet and overall conditions in
the federal funds market.
231
Initial Business Plan, at 31 (“
[A]s a regulated, audited, 100% reserve bank that plans to deposit its cash
directly at the Federal Reserve, [Custodia] expects to be a novel solution in this space and
the only one of its kind with regulator-enforced proof of solvency.”); Initial Business
Plan, at 115 (“As a fully regulated, audited, 100% reserve bank that (at least initially)
intends to deposit its cash directly at the Federal Reserve, [Custodia] expects that it
would likely be the only U.S. dollar issuer of a digital asset in the form of a negotiable
instrument that can prove its solvency.
.”).
232
The risk that Custodia may undergo pronounced rapid growth may be mitigated by
the imposition of regulatory capital requirements in that such growth would cause
breaches in minimum capital ratios unless accompanied by concomitant capital raises.
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and result in a new, meaningful, and volatile source of demand for Federal Reserve
liabilities.
If the Board were to approve Custodia’s application, based on the foregoing and
all the facts of record, it would exercise its discretion under section 9(13) of the Act, and
impose a condition under section 9(1) of the Act, to prohibit Custodia from issuing Avits
at least until such time as the Board’s significant concerns regarding safety and
soundness have been addressed. The inability to conduct such activity may adversely
affect Custodia’s future earnings prospects as a state member bank.
c. Prime Services
As part of its Prime Services business, Custodia proposes to offer a platform that
enables customers to lend crypto-assets held in trust accounts at Custodia for a fee. 233 In
addition, Custodia would offer a “fiat on/off ramp” for crypto-assets. 234 Under this
service, customers would be able to buy and sell qualifying crypto-assets (
) by using their deposit balances (for purchases of qualifying crypto-assets) or
custodied crypto-assets (for sales of crypto-assets). Customers would request a bid for
their purchase or sale through Custodia’s online portal, and Custodia’s platform would
request bids from “ .” 235
233
Initial Business Plan, at 12–15, 69; First AI Response, at 13, 35; Second AI
Response, at 2–3, 15–16, 18–19.
234
Initial Business Plan, at 40.
235
Id., at 40–43.
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Based on the descriptions provided by Custodia to date, the Board has not
determined whether certain of these activities would be conducted as principal; 236
therefore, the Board is not able to evaluate whether it would be appropriate to consider
national bank permissibility and limiting such activity under section 9(13) of the Act.
However, the Board has concerns regarding the risks posed by these activities, including
operational, compliance, and illicit finance risks. The Board would want to
comprehensively review the effectiveness of planned systems for such novel and
unprecedented activities. At the time of the Reserve Bank’s examination, Custodia had
not yet designed its policies, procedures, or controls for these activities. Among other
things, the Board would like to better understand Custodia’s process for determining that
a crypto-asset eligible for these services is not a security. 237 The Board would also want
to review disclosures and customer-facing materials, in light of the risks of holding
crypto-assets, as discussed above. 238
236
In the context of section 24 of the FDIA, the FDIC has previously stated that agency
relationships “must be examined on an unbundled basis”— just because an activity is
referred to as an “agency” or involves some elements of agency does not mean that the
entire activity is conducted “as agent.” FDIC Interpretive Letter FDIC-97-7, at 1
(October 20, 1997) (1997 WL 1050940).
237
See, e.g., Memorandum and Order, Securities and Exchange Commission v. LBRY,
Inc. (D.N.H. November 7, 2022) (No. 21-cv-260-PB). If Custodia were to act as a broker
for sales of an unregistered security, it could be liable for the purchaser’s losses. See 12
U.S.C. § 77l (establishing liability for offering or selling an unregistered security); Pinter
v. Dahl, 486 U.S. 622, 647 (1988) (holding that this liability extends to a person or entity
that successfully solicits the purchase of an unregistered security, motivated at least in
part by the desire to serve its own financial interests or those of the security’s owner). In
addition, it would be subject to specific legal requirements regarding securities
brokerage.
238
See supra notes 170–173.
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Given that these activities are novel and unprecedented for state member banks, if
the Board were to approve Custodia’s application, based on the foregoing and all the
facts of record, it would impose a condition under section 9(1) of the Act to prohibit
Custodia from engaging in these activities, pending further review and assessment of the
permissibility considerations and the adequacy of the control environment. The inability
to conduct such activity may adversely affect Custodia’s future earnings prospects as a
state member bank.
3. Considerations Related to Admission of an Uninsured Deposit-Taking
Bank
The Board has considered whether admission to membership of an uninsured bank
that generally accepts deposits is consistent with the purposes of the Act. One of the
principal goals of the Act is to promote the effective operation of the U.S. economy. A
key tool in achieving this goal is protecting the stability of the banking system, and since
the 1930s, federal deposit insurance has been central to achieving that stability. Prior to
the establishment of deposit insurance, U.S. banks were highly susceptible to runs, and
bank failures in the early 1930s had a devastating impact on the U.S. economy. In the
Banking Act of 1933, 239 Congress added section 12B to the Act, later separately enacted
as the FDIA, which provides for the establishment of the FDIC and federal deposit
insurance. Importantly, the Banking Act of 1933 provided that federal deposit insurance
would be extended to every member bank as of July 1, 1934, and to every bank that
239
Pub. L. No. 73-66, 48 Stat. 162, 168.
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became a member of the Federal Reserve System after that date. 240 Beginning in 1950,
every member bank in the business of receiving deposits other than trust funds became an
insured bank at the time it became a member of the Federal Reserve System. 241
Admission of an uninsured member bank that accepts deposits other than trust
funds would be unprecedented in modern times and could present risks to the stability of
the Federal Reserve System by omitting a critical tool in preventing bank runs. 242
Although Custodia contends that certain aspects of its business plan reduce the bank’s
susceptibility to runs, Custodia may be subject to runs and could cause contagion to
affect other institutions in the event of a run. 243 The global crypto-asset industry, on
which Custodia has focused its business model, is highly susceptible to runs, as recent
events have demonstrated. 244 These risks are heightened with respect to Avits,
240
48 Stat., at 169–70, 172–76.
241
Act of September 21, 1950, sec. 2, § 4, ch. 967, 64 Stat. 873, 875. In 1991, this
provision was amended such that membership in the Federal Reserve System did not
automatically confer insured status. See FDICIA § 115, Pub. L. No. 102-242, 105 Stat.
2236, 2249 (1991). However, the legislative history of this provision indicates that the
change was intended to require all banks seeking insurance to obtain the approval of both
the FDIC and appropriate Federal banking agency, matching the statutory process for
federal savings associations. See 138 Congressional Record 3093, 3115 (1992).
242
While there are currently 49 uninsured member banks that are nondepository trust
companies (including one uninsured state member bank), there are no uninsured member
banks that accept deposits other than trust funds.
243
For example, in 2008 and 2020, money market mutual funds, which could be
compared to uninsured deposit-taking entities, experienced significant stress due to
outflows, which resulted in contagion. See, e.g., President’s Working Group on Financial
Markets, Overview of Recent Events and Potential Reform Options for Money Market
Funds (December 2020).
244
FSOC Report, at 46–53.
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redemptions of which would be visible on the blockchain. These financial stability risks
are worsened by Custodia’s managerial deficiencies, as revealed by the recent pre-
membership examination.
Further, the Board would need to create bespoke regulatory and supervisory
frameworks for Custodia, to ensure it is subject to supervision and regulations that are
appropriate for an uninsured institution engaged in significant deposit-taking activities. 245
Finally, as discussed above, lack of deposit insurance coverage by the FDIC means that
any resolution of Custodia would take place outside the FDIC’s receivership regime. 246
The Board acknowledges that, notwithstanding the lack of precedent, Congress
has designed a legislative framework that makes it possible for an uninsured depository
institution to become a state member bank. Future applicants may present business
models and control frameworks to overcome the concerns presented by uninsured
deposit-taking banks. But in light of the heightened risks of Custodia’s business model
and currently insufficient control framework, the Board does not believe that Custodia
has overcome these concerns or provided sufficient justification to break from long-
standing precedent.
* * *
245
See, e.g., supra notes 24–27; part II.C.2.
246
See supra part II.A.4.
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Based on the foregoing review and all the facts of record, the Board has
determined that the considerations relating to the corporate powers factor are so adverse
as to be sufficient grounds on their own for warranting denial of Custodia’s application.
D. Convenience and Needs Considerations
The Board has also considered the convenience and needs of the community to be
served. 247 In considering the convenience and needs factor for membership applications
by de novo banks, the Board has traditionally considered Community Reinvestment Act
(“CRA”) plans for the community to be served, business plans as they relate to consumer
compliance, and results from pre-membership examinations conducted by the Federal
Reserve Banks. 248
Given its unique charter, Custodia would not be subject to the CRA, 249 and
therefore, there was no CRA plan for Reserve Bank examiners and the Board to consider.
The Board has therefore reviewed Custodia’s plans for serving the convenience and
247
12 CFR 208.3(b)(3).
248
The pre-membership examination focused on Custodia’s core banking activities.
Based on the proposed business plan, Custodia would initially only serve business
entities. In addition, the Wyoming statute chartering Custodia as an SPDI prohibits the
bank from originating loans. Wyo. Stat. § 13-12-103(c). Accordingly, Reserve Bank
examiners did not conduct a consumer compliance pre-membership exam.
249
Custodia would be exempt from the CRA because banks that do not grant credit to
the public in the ordinary course of business are classified as special purpose banks to
which the CRA requirements do not apply under 12 CFR 228.11(c)(3). The Wyoming
statute chartering Custodia as a special purpose depository institution prohibits the bank
from originating loans. Wyo. Stat. § 13-12-103(c). In addition, the CRA only applies to
“regulated financial institutions,” which are in turn defined as “insured depository
institutions,” as defined in 12 U.S.C. § 1813. Custodia is not seeking deposit insurance
with the FDIC.
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needs of the community it has identified. Custodia defines the community it will serve as
the crypto-asset market comprised of “
,” as well as . 250 Custodia states that it will serve as “a
market ‘utility’ for the regulatory-compliant portion of the crypto-asset community.” 251
Custodia believes that it will meet the convenience and needs of this community by
serving as a supervised bank that provides customers access to both national currency and
crypto-asset products. Custodia also represents that its entry into the market would give
the crypto-asset industry more banking options.
The Board most recently approved two membership applications from two
uninsured (nondepository) state chartered institutions: Warehouse Trust in 2010 and ICE
Trust in 2009. 252 In these cases, the applicants were viable institutions, which provided
valuable services as market utilities and reduced risks within their communities,
consistent with the convenience and needs factor. 253 In contrast, and as described above,
250
Initial Application, at 7; see also Initial Business Plan, at 39.
251
Initial Application, at 7.
252
Warehouse Trust Company LLC, 96 Federal Reserve Bulletin B13 (2010); ICE US
Trust LLC, 95 Federal Reserve Bulletin B73 (2009).
253
The Board found that Warehouse Trust, as the primary trade repository for credit
default swap (“CDS”) contracts, met the convenience and needs factor as an essential
component of the market infrastructure for CDS transactions and found benefit in
bringing Warehouse Trust into the Federal Reserve System and subjecting it to oversight.
In addition, the Board found benefit in granting membership to Warehouse Trust because
membership would promote greater transparency by making CDS data publicly available.
Warehouse Trust Company LLC, 96 Federal Reserve Bulletin B13, B14 (2010). The
Board found that ICE Trust met the convenience and needs factor as a central
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the Board has substantial doubts regarding Custodia’s ability to operate in a safe and
sound manner as proposed, which in turn indicates Custodia will not be able to meet the
convenience and needs of its community. 254 Instead, the current record indicates
Custodia could pose significant risk to its community.
Custodia is not seeking deposit insurance with the FDIC, and admission of an
uninsured member bank that accepts deposits (other than trust deposits) would be
unprecedented since the establishment of federal deposit insurance. 255 To the extent that
Custodia would be able to expand the deposit capacity available to the crypto-asset
market and attract depositors, Custodia has not proposed a sustainable business plan that
would address the significant risk to its customers in the event of its potential failure. 256
The risk to Custodia’s depositors is highlighted by the managerial weaknesses, discussed
above, revealed in the pre-membership examination. 257 Accordingly, in contrast to the
membership applications submitted by Warehouse Trust and ICE Trust, Custodia has
counterparty for CDS transactions that significantly reduced systemic risks associated
with counterparty credit exposures in CDS transactions, and thereby enhanced the
stability of the overall financial system. The Board also found that bringing ICE Trust
into the Federal Reserve System would promote greater market transparency by making
market data more publicly available. ICE US Trust LLC, 95 Federal Reserve Bulletin
B73, B76 (2009). The Board also found that the financial factor with respect to both
entities was consistent with approval. Id., at B75; Warehouse Trust Company LLC, 96
Federal Reserve Bulletin B13, B14 (2010).
254
See supra parts II.A, II.B.
255
See supra part II.C.3.
256
See supra parts II.A.4 and II.B.
257
See supra part II.A.
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presented a business plan that is unlikely to provide sustainable services to its community
and that exposes potential customers to significant risk.
The Board has also considered the consumer laws and regulations that may apply
to Custodia’s general business model, including its Avits. Custodia has generally
challenged the application of federal consumer laws and regulations, taking the position
that they do not currently apply to its proposed businesses (including Avits); therefore,
Custodia has not implemented any specific controls to comply with such laws and
regulations. 258 The Board has concluded that, at a minimum, the prohibition on unfair or
deceptive acts or practices in section 5 of the Federal Trade Commission Act would apply
to Custodia.
In summary, the Board has considered Custodia’s purported benefits to its
community. Custodia has not demonstrated that it could operate in a safe and sound
manner, which is a necessary precondition to being able to meet the convenience and
needs of its community. Instead, the current record indicates Custodia could in fact pose
significant risk to its community. It is also unclear whether Custodia would be able to
comply with any applicable consumer protection requirements given the inherent features
of its intended business model.
258
See First AI Response, at 35 (“Custodia does not intend to offer services to natural
persons for at least .
Consequently, it has not done further analysis on potential implications under the
Electronic Funds Transfer Act, Regulation E or any other relevant laws applicable to
consumers.”); Third AI Response at 11–12, 29–31.
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III. Conclusion
Based on the foregoing and all the facts of record, the Board has determined that
approval of Custodia’s application for membership in the Federal Reserve System would
be inconsistent with the managerial, financial, and corporate powers factors that the
Board is required to consider under the Act. 259 Inconsistency with any one of these
factors is sufficient to warrant denial of Custodia’s application, 260 and other factors the
Board is required to consider under the Act do not lend sufficient weight to warrant
approval of Custodia’s application.
It is therefore the judgment of the Board that Custodia’s membership application
should be, and hereby is, denied without prejudice to future applications by Custodia.
By order of the Board of Governors, 261 effective January 27, 2023.
Ann E. Misback (signed)
Ann E. Misback
Secretary of the Board
259
12 U.S.C. § 322.
260
See supra note 7.
261
Voting for this action: Chair Powell, Vice Chair Brainard, Vice Chair for Supervision
Barr, Governors Bowman, Waller, Cook and Jefferson.
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