Custodia's Lawsuit Against The Fed Exposes The Fractional Reserve Banking Model

Custodia, an innovative bitcoin and cryptocurrency bank seeking to establish a charter in Wyoming, took a bold step by filing a groundbreaking lawsuit against the Federal Reserve on June 7, 2022. The legal action stemmed from the Fed’s inexplicable delay in approving Custodia’s application for a “Master Account,” a process that typically takes 5-7 days but had been pending for over two years. This extended delay, eventually turning into a denial on January 27, 2023, raised concerns about potential biases favoring incumbent banks over disruptive newcomers like Custodia. The outcome of this lawsuit could have profound implications for the future of banking regulations and reshape the entire industry.

Custodia’s disruptive approach aims to revolutionize the banking model by positioning itself as the least risky bank in the U.S., which would make it highly attractive to investors. It does this through its charter as a SPDI bank, or special purpose depository institution. These SPDI banks “are fully-reserved banks that receive deposits and conduct other activity incidental to the business of banking, including custody, asset servicing, fiduciary asset management and related activities,” according to the official website. In other words, their business model is to make money from banking services and take far less risk than any other bank in the world. The key aspect of Custodia’s strategy involves completely eliminating the controversial practice of fractional reserve lending, a move that no other bank in the United States has undertaken. If Americans had any idea what kind of risk they take by depositing money into a fractional reserve bank, they would likely revolt.

SPDI banks’ commitment to eliminating fractional reserve lending would likely strike a chord with institutions seeking to mitigate risks and hedge their investments. Additionally, a bank like Custodia could leverage Wyoming’s pioneering regulatory framework for digital assets, providing customers with a system that ensures safety and security without resorting to rehypothecation or over-leveraging. This distinctive offering sets banks like Custodia apart from traditional banks and positions it as a trusted partner for institutional investors.

The lawsuit filed by Custodia against the Federal Reserve marks a historic milestone. As the case proceeds to the discovery phase, previously undisclosed internal emails and documents within the Fed are expected to come to light. This transparency could unveil any potential advantages afforded to incumbent banks and shed light on the fairness of the approval process. Custodia will also likely have the opportunity to conduct interviews under oath with prominent Fed officials, including Jay Powell and Kansas City Fed Governor Esther George. Such testimonies could reveal further insights into the approval process for Moonstone Bank, in which FTX/Alameda invested, raising questions about proper handling and fairness.

While the outcome of the lawsuit remains uncertain, a favorable ruling for Custodia could result in a substantial influx of institutional capital into Wyoming. The state’s digital asset regulatory framework, coupled with Custodia’s disruptive business model, offers clarity and priority for digital assets, attracting institutional investors seeking reliable and innovative banking solutions. The potential impact of Custodia’s success extends beyond the banking industry, potentially triggering significant price movements in Bitcoin and influencing future banking regulations. As the case progresses and the court demands an administrative record from the Federal Reserve, the urgency and significance of this lawsuit are expected to become more apparent within the U.S. courts.

In her March 2023 newsletter, Lyn Alden bluntly puts it, “From a depositor perspective, banks are essentially highly-leveraged bond funds with payment services attached, and we naively trust them with our hard-earned savings.” Where would you rather keep your money, in a “highly-leveraged bond fund,” or with Custodia?

If the answer to that question isn’t clear, it’s time for a wakeup call.

The philosophy is simple: instead of the famous “Don’t be evil,” mantra, the regulations at SPDI banks make it so that “You can’t be evil.” Unlike traditional banks, an SPDI bank like Custodia would prioritize the security and well-being of its customers.

This case may serve as a reckoning, and could become a watershed event that extends far beyond bitcoin, exposing the overreach of the Federal Reserve on our money and the profound unfairness of our banking systems. Technological advancements have brought these issues to the forefront, demanding action.