Crypto bank Custodia’s fight with the Kansas City Federal Reserve for access to key banking services endangers the whole US banking system.
That’s according to a brief filed with the court on Wednesday by the nation’s 11 other Federal Reserve banks as part of Custodia’s appeals case.
The ability to bar risky banks from access to the Fed’s system “is a fundamental and universal risk-management tool inherent in banking,” according to the brief.
“Custodia’s position finds no support in law or logic, and the court should reject it.”
In short, the regional banks fear that if Custodia wins its case, the Federal Reserve will be forced to grant access to all banks — no matter how shaky.
These are banks that could facilitate money laundering, fail to prevent hacks, transact with other shaky businesses, experience a lot of downtime in their systems, and a plethora of other risks, they argue.
The fight highlights the crypto industry’s complaints that the US regulatory establishment has shut them out of essential banking services.
Some even label it a conspiracy and compare it to Operation Choke Point, which was used during the Obama administration to cut off banking services to industries like gun manufacturers and porn providers.
Wyoming beginnings
Caitlin Long founded Custodia to fill this gap in crypto banking.
The firm attained a licence to custody crypto in 2020 under Wyoming’s industry-friendly laws.
Custodia then applied to its regional central bank, the Kansas City Fed, for access to a master account.
The Kansas City Fed is one of 12 regional banks that function as the operating arm of the Federal Reserve.
They’re effectively banker’s banks, supplying America’s 4,500 small banks with access to Fed liquidity and payments systems.
A master account grants access to these services. Without one, a bank must transact via go-betweens.
After waiting in vain for a master account, Custodia sued the Kansas City Fed in 2023 on the basis that as a depository institution, it was required to grant it a master account.
The bank argued the opposite — while it can grant master account access to depository institutions, it doesn’t have to.
The Federal Reserve later said Custodia had deficiencies in its risk management practices, such as exposure to crypto, a narrow and volatile sector of the economy.
Custodia lost its case and appealed in April.
Powerful allies
Custodia has some powerful allies. Two former solicitors general have filed briefs in support, echoing arguments that the situation amounts to a “Choke Point 2.0.″
Meanwhile, Custodia’s court battle has cost the business, as it has had to lay off nine of its 36 employees.
Custodia is “operating with two hands tied behind our bank,” Long told DL News recently.
“We’ve been hamstrung by what the Fed did to us.”
Joanna Wright writes about policy and regulation. Reach out to her at joanna@dlnews.com.
