The United States Federal Reserve has rejected Wyoming-based crypto-centric bank, Custodia’s application to become a member of its exclusive payment system.

In a press release last evening (January 27), the Fed explained that it rejected the application based on the fact that Custodia’s proposed business plan, and focus on crypto assets, presented significant safety and soundness risks. Also, the bank does not have federal deposit insurance.

The bank, which describes itself as a “special purpose depository institution”, reportedly told the Fed that it planned to engage in activities that include issuing crypto assets on decentralised networks. Custodia, which was previously known as Avanti, uses a special state license from Wyoming for banks that deal with cryptocurrencies.

In 2022, Avanti sued the Kansas City Federal Reserve Bank for delaying a decision to grant it special access to the Fed, known as a master account. Some market analysts say the move is not surprising.

Analysts weighs in on the rejection

One analyst, Jaret Seiberg, managing director at Washington-based research group Cowen, in an email to MarketWatch said, “we do not see the decision as a surprise. To us, the Fed wants to prevent states from chartering entities to support crypto that can access the payment system and Fed liquidity programs.”

He posited, “we believe this explains why it blocked Custodia from becoming a state-member bank and why it issued the broader policy statement. We do not expect the Fed to give Custodia a Master Account.”

Dennis Kelleher, president and CEO of Better Markets, a group that’s against financial deregulation, in an interview with MarketWatch contended that “the crypto industry and its political allies have been trying to get access to and interconnected with the core of the banking system because that would be incredibly lucrative for their profits.

He believes the move is beneficial for taxpayers. However, Custodia’s failure, he said will be a disappointment to the crypto industry.

Swift response from Custodia

 In a swift response, Caitlin Long, chief executive officer of Custodia penned a statement saying, “Custodia is surprised and disappointed by the Board’s action today. The Board’s denial is unfortunate but consistent with the concerns that Custodia has raised about the Federal Reserve’s handling of its applications, an issue we will continue to litigate.”

Recently, the Fed highlighted that crypto activities are inconsistent with safe and sound banking practices, as shown by the significant volatility in the crypto industry in the past year. In a separate but related move yesterday, the Fed issued a policy statement with the goal of encouraging an equal playing field for all banks with a federal supervisor, regardless of deposit insurance status.

Typically, the Federal Deposit Insurance Corporation provides insurance that protects bank accounts if a bank fails but the Fed indicated that uninsured and insured banks supervised by the Board will be subject to the same limitations on activities.

The statement declared that “banks will need to demonstrate in their applications that activities they engage in are allowed under the law, and have risk management processes, internal controls, and other measures in place that are “appropriate and adequate for the nature, scope, and risks of its activities.”