The U.S. Federal Reserve Board has denied Wyoming-based Custodia Bank’s application to become a Federal Reserve member, despite the state having one of the most advanced crypto regulatory frameworks in the United States.



According to the Federal Reserve, Custodia’s novel crypto-focused business model was “inconsistent with safe and sound banking practices,” it described in an earlier report.



Custodia Rejected Despite Advanced Regulations



The Fed also cited Custodia’s state charter as a Special Purpose Depository lacking Federal Deposit Insurance and the inability of its risk framework to detect money laundering and terrorism activities as additional red flags.



Responding to the Federal Reserve’s rejection, Custodia said it was “surprised” and “disappointed,” having exceeded regulations governing traditional banks. It said the rejection would be something that it would “continue to litigate.”




STATEMENT FROM CUSTODIA BANK about today's Federal Reserve action on its membership application. Its master account application remains pending: pic.twitter.com/QkMjcT508J — Custodia Bank (@custodiabank) January 27, 2023




Custodia, formerly Avanti Bank , was founded by Cailtlin Long, a Wall Street veteran who worked for over twenty years at some of the biggest financial institutions in the United States, including Morgan Stanley, Credit Suisse, and Salomon Brothers.



After her exposure to Bitcoin and talking to Morgan Stanley’s CTO, Long moved back to her home state of Wyoming. She later identified a legal framework for crypto custody as pivotal to bridging the gap between traditional finance and crypto. Having worked in the Wyoming legislature, Long oversaw the passage of thirteen crypto law s in two years.



Custody a Crucial Focus of Wyoming’s Laws



Long’s regulations went into the nitty-gritty of defining custody. It gave banks the green light for custodianship, and protected coders from lawsuits by declaring smart contract code free speech. The laws also defined the owner of a private key as the owner of any crypto under that key’s control. This definition was a radical departure from traditional banking, where a bank’s insolvency can mean a depositor’s funds are lost.



New regulations also legalized a non-lending Special Purpose Depository Institution that did not need Federal Deposit Insurance to manage risk. Instead, these state-chartered institutions were compelled to hold sufficient capital to honor 100% of customer withdrawals.



Many crypto projects and companies soon migrated to the Mountain West state, including Kraken, Ripple, and Solana. CityDAO, a decentralized land ownership experiment, owns 40 acres in Wyoming. Senator Cynthia Lummis, one of the authors of the Lummis-Gillibrand Responsible Financial Innovation Act, is a Republican from the state.



State Charter Falls Frustratingly Short



The latest Fed ruling shows that a state charter does not guarantee admission as a Federal Reserve member. The rubber stamp would have allowed the bank to enjoy the same public trust and reputation as the Fed.



In its response, Custodia pointed out that a solvent business actively seeking federal regulation should have stood apart from “reckless speculators and grifters,” which brought some banks to their knees during the recent crypto meltdown. It did not directly respond to any measures under the state charter that would mitigate the risk of money laundering and terrorism financing brought up by the Federal Reserve.



It is in the unfortunate position of being a novel non-lending institution trying to win Federal approval for membership in a group of most lending institutions governed by old laws. Unless Congress refreshes laws to include crypto custodians , Custodia could be fighting a losing battle.



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