Professor Emmert Among Experts Weighing in on Financial and Cryptocurrency Lawsuit
01/31/2024
IU McKinney Professor Frank Emmert is among the experts supporting a lawsuit with an amicus brief, the outcome of which could have far-reaching consequences for the financial and cryptocurrency industries. Cryptocurrency law is among Professor Emmert’s many areas of expertise.
The case is Custodia Bank, Inc. v. Board of Governors of the Federal Reserve System and Federal Reserve Bank of Kansas City. Professor Emmert is among the experts to support the case with an amicus brief.
Custodia Bank was founded in Wyoming and has a state banking charter as a Special Purpose Depository Institution, or SPDI. It was founded by Caitlin Long, a 22-year veteran of Wall Street. Long wants to use the more liberal regulatory framework in Wyoming to build a bank that can do fiat and crypto transactions and build a bridge between the two worlds. Current providers or crypto services are not regulated in the same ways that banks are. There are no federal laws and the regulatory acts by the Securities and Exchange Commission and other federal agencies are patchwork, inconsistent, and motivated more by the personal preferences of the leaders of those institutions than by market needs or congressional mandates and value judgments, Professor Emmert said.
To provide banking services beyond Wyoming and be able to offer competitive services, Custodia applied for a master account with the Federal Reserve, which would basically give it a federal charter, he said. After more than 18 months of review the Kansas City Federal Reserve denied the application.
Professor Emmert explains why this matters:
“First, this has basically never happened to a bank holding a state charter. Second, the reasons given are weird on several levels. For example, without providing specific evidence, the Board argued that Custodia management is not sufficiently competent. This smacks of elderly white males rejecting a young and dynamic company led by a young and dynamic woman.
“Most importantly, however, the board took issue with Custodia's proposal to be dealing in certain cryptocurrencies. Supposedly, the risk of such transactions would be too high. This shows a fundamental misunderstanding of the transactions proposed by Custodia or a fundamental lack of willingness to try to understand. In fact, Custodia would never be liable for changes in the valuation of crypto held by it on behalf of customers. Rather, it would be similar to holding foreign currency like Euro. The customer can get their forex back or the equivalent in USD at the time when they are asking. Same with crypto. Nobody could ever get the value of some earlier time when they deposited the forex or crypto.
“Even more important, if customers are depositing funds with Custodia (saving) and the bank also engages in lending transactions, it has to have 100% of deposits in unencumbered reserves. Compared to traditional banks, they hold typically only about 10% of their lending portfolio in cash or near money reserves. In some cases, the reserves have been as little as 5-6%. Thus, if more than 5-10% of customers want their money back at the same time, we speak of a bank run, the bank has to close at least temporarily because it does not have the cash. This cannot possibly happen with Custodia because it has to hold 100% of deposits.
“Finally, the board argued that Custodia overall presents a higher risk in case of turbulence. This is adding insult to injury because the Fed has recently authorized the issuing of Bitcoin ETFs by several of our largest banks, in spite of the fact that these are less secure than the business model of Custodia. In this context, the Fed conveniently forgets that basically all of these largest banks would not exist anymore had they not been bailed out with trillions of dollars of taxpayer money several times over in recent decades. Basically, the Fed is arguing that the largest banks are safe because they will be bailed out if they screw up, while Custodia is potentially not safe since it is not systemically important (i.e. large enough) and would not get bailed out.
“We'll see what the litigation is going to bring but the fight will be a long one.”
