Wyoming Defends its Crypto Banks in Face of Fed Criticism

By CJ Baker

Special to the Wyoming Truth

Over the years, the State of Wyoming has sued the federal government over everything from restrictions on oil and gas production to vaccine mandates to wolves. But Wyoming officials recently headed to federal court over something different: To push back against what it sees as a federal attack on the state’s crypto-friendly banking laws. 

Wyoming has sought to become a pioneer in the cryptocurrency space, hoping to entice the industry to set up shop in the state. But one of the state’s most ambitious efforts — the creation of a new type of bank called Special Purpose Depository Institutions (SPDIs) — has run into stiff resistance from federal regulators.

After dragging its feet for more than two years, the Federal Reserve Board announced in January that it would not allow Custodia, a Cheyenne-based SPDI, to become a member of the Federal Reserve System and access the institution’s payments system. The board released the details behind its decision in late March — a scathing 86-page critique that argues Custodia’s plans are underdeveloped, unlikely to succeed and generally too risky. The Fed criticized the company’s management, financial condition and focus on crypto transactions and said its plans would subject customers “to significant risks.”

For its part, Custodia has said it offered a “safe, federally-regulated, solvent” proposal and that the Fed’s order stemmed from a general bias against digital assets. The company is challenging the denial in Wyoming’s U.S. District Court, asserting federal law requires the Fed to provide it with a master account.

The State of Wyoming is now seeking to intervene in the case, contending the Fed’s denial amounted to an attack on the state’s SPDI regulations. In filings submitted last week, Wyoming Attorney General Bridget Hill and her team accused the Federal Reserve and the region’s Federal Reserve Bank of Kansas City of treating the state’s SPDIs as “second-class banks” and engaging in “regulatory discrimination.”

In its January decision, the Fed said it could approve banks like Custodia’s in the future. However, the attorney general’s office said the uncertainty created by the Fed’s delay and denial of Custodia’s application has “chilled” the creation of SPDI banks in Wyoming. The Wyoming Division of Banking approved four SPDIs between 2020 and 2021— Kraken Bank, Custodia, Wyoming Deposit & Transfer and Commercium Financial — but none are operational, as none have been allowed to connect to the federal payments system.

Wyoming developed its regulatory framework in conjunction with the Kansas City Fed, but when the Board of Governors recently denied Custodia’s application for a master account, the Fed’s current skepticism about digital assets was glaringly evident.

In search of a safer bank

In a late March filing, Fed attorneys added that “the cryptocurrency industry on which [Custodia] pins its entire business model [currently] suffers extreme volatility and loss, and the depository institutions with the closest ties to these activities have collapsed into liquidation or federal receivership.” They ticked off a list of collapsed crypto businesses, including Celsius Network, Voyager, BlockFi and FTX.

However, Wyoming set up its SPDIs with the specific intent of preventing the risky and reckless behavior that caused the collapse of many of those businesses. For example, unlike Celsius — whose business model was based on offering eye-popping yields on the bitcoin, ether and other cryptocurrencies deposited with the company — SPDIs are barred from making loans. Instead of paying out interest, Custodia intends to charge customers for securely holding their digital assets, for payment services and for cash/crypto conversions. 

To avoid the risk of a bank run — in which customers pull too much cash out of a bank too quickly and cause it to become insolvent — Wyoming SPDIs are also required to keep enough cash or similarly liquid assets in reserves to cover 100% of their deposits, so customers can theoretically withdraw their holdings at any time.

Sen. Chris Rothfuss (D-Laramie), who co-chairs the Legislature’s blockchain committee, has said Wyoming’s laws would have prevented last year’s collapse at FTX, which allegedly mishandled billions of dollars worth of customers’ digital assets. Custodia and its CEO, Caitlin Long, have said their bank offers an regulated alternative to “the reckless speculators and grifters of crypto that penetrated the U.S. banking system” and brought “disastrous results for some banks.”

“The Court ought not countenance Defendants’ guilt-by-association scaremongering,” Custodia attorneys wrote last week, “especially when the State of Wyoming and its Division of Banking are watching over the eligible depository institutions they have chartered.”

They added that fed officials “are arguing, in essence, that state banking authorities cannot be trusted to do their job and properly regulate the banks whom they charter.”

The Wyoming Attorney General’s Office said the Fed “overlooked, ignored and disregarded” many of the protections the state put in place for SPDIs and is favoring federally regulated banks. Despite expressing skepticism about Custodia and other Wyoming SPDIs, the AG’s office noted that the Fed is allowing the older state-chartered Bank of New York Mellon to offer the same types of crypto custody services.

The state wants presiding U.S. District Court Judge Scott Skavdahl to declare that the Fed unlawfully discriminated against Wyoming’s SPDI banks and that the Kansas City Fed mischaracterized the state’s laws and regulations. 

Whether the state will gain any traction remains to be seen. Court filings say both the Federal Reserve and its Kansas City bank will object to Wyoming even joining the case. Fed officials will detail their positions in the coming days.