Federal Reserve Says Custodia’s Crypto-Focused Business Model Is ‘Inconsistent’ With Approval

The Federal Reserve Board argued that Custodia Bank’s proposed business model was “inconsistent” with approval in an order explaining its denial of the Wyoming-based crypto bank’s application for membership.

Custodia’s membership application, as well as its application for a master account, was denied in January, 18 months after the applications were initially filed. Custodia, formerly known as Avanti Bank, filed suit against the Federal Reserve in June 2022, alleging that the central bank was unlawfully delaying its decision, and filed an amended complaint earlier this year alleging a Fed conspiracy to block it.

At the time of Custodia’s denial, the Federal Reserve issued a brief statement explaining its position that Custodia’s “novel business model and proposed focus on crypto-assets presented significant safety and soundness risks,” and that the bank did not have a sufficient risk management framework to address crypto-related risks like money laundering and terrorism financing.

Friday’s 86-page release, however, is the first time the central bank has expanded on its reasoning for the denial. The FRB argued that Custodia had insufficient risk management and controls, “particularly with respect to overall risk management; compliance with the Bank Secrecy Act and U.S. sanctions … financial projections, and liquidity risk management practices.”

The Board also argued that Custodia’s revenue model, which “relies almost solely upon the existence of an active and vibrant market for crypto-assets” makes it vulnerable to market volatility, even though the Board admitted that “Custodia appears to have sufficient capital and resources to sustain initial operations.”

“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,” the Board reasoned.

Aside from its other concerns, the Board argued that Custodia’s financial plans were “so adverse as to present sufficient grounds on their own for warranting denial of the application,” a statement it reiterated while detailing different aspects of Custodia’s application that it objected to.

Custodia has pushed back on the Fed’s rejection, both through its ongoing lawsuit and in a statement Friday which called the order “the result of numerous procedural abnormalities, factual inaccuracies that the Fed refused to correct, and general bias against digital assets.”

“Rather than choosing to work with a bank utilizing a low-risk, fully-reserved business model, the Fed instead demonstrated its shortsightedness and inability to adapt to changing markets,” the Custodia statement said. “Perhaps more attention to areas of real risk would have prevented the bank closures that Custodia was created to avoid. It is a shame that Custodia must turn to the courts to vindicate its rights and compel the Fed to comply with the law.”

The membership was denied without prejudice, meaning that Custodia would, in theory, be able to apply for membership again in the future.