Caitlin Long had sought to be one of Washington's biggest allies for bringing crypto assets into the regulated banking space. Instead, she has found herself one of its biggest adversaries. Long is the Founder and CEO of Custodia Bank, a Cheyenne, Wyo,-based special purpose depository institution that aimed to be a bridge between digital assets and the traditional banking system. However, those plans were stymied when the Federal Reserve Bank of Kansas City denied Custodia a so-called master account, effectively cutting the bank off from the central bank's payment rails. Custodia's master account rejection was one of a number of actions that Long and other say amount to cutting off crypto banking at the knees. In this Leaders, she discusses these regulator developments, what they mean for the sector broadly, and how her firm is fighting back against them.
Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Kyle Campbell (00:09):
Hello and welcome to Leaders. My name is Kyle Campbell and I'm a reporter with American Banker. Today we're going to be discussing regulation of crypto and digital assets. And joining me for this discussion is Caitlin Long founder and CEO of Custodia Bank, which is a Wyoming based institution that seeks to be a compliant bridge between the crypto world and traditional finance. And before that, she spent two decades working in investment banking at Morgan Stanley Credit Suisse. She has a law degree and a master's in public policy from Harvard University as well as Bachelor's from University of Wyoming. She's been heavily involved in blockchain groups, both in Wyoming and elsewhere, and she played an instrumental role in the development of the special Purpose Depository Institution chartering framework in her home state of Wyoming. Caitlin, thanks for joining us.
Caitlin Long (01:11):
Good to be with you, Kyle. Thank you.
Kyle Campbell (01:12):
So maybe a good place to start would be with how you got involved with crypto in the first place and why you remain interested in it and see it as a critical part of the financial landscape moving forward.
Caitlin Long (01:26):
I got involved with it and came across it first in 2012. Thought it was interesting, got came across it in alternative schools of economic thought, and at the time I was working on a very, very large transaction that involved the General Motors Pension Fund, transferring $30 billion of assets and liabilities to Prudential, and we had to figure out how to get those assets and liabilities transferred same day. And back then stocks and bonds settled t plus three days. So figuring out how to move all those different asset classes same day caused me to take very deep dive into the operations. And back then we moved, I think three and a half billion in cash between two non-banks. That required getting the New York Fed involved just to make sure that the wire cleared same day because it was so large. So just really got into the operational weeds and started to realize how screwed up the back office of the financial system really is. And at that time I understood that this technology could streamline that.
Kyle Campbell (02:31):
And so is that still where you see the biggest gains for banking and finance is in the sort of backend capabilities of blockchain and crypto type assets, or are some of the more forward public facing sides of it? Do you see value in that as well? What do you see as the role for crypto moving forward?
Caitlin Long (02:53):
At a fundamental level, what blockchain is a way to avoid the need to duplicate and reconcile the very same data. So when a transaction goes between Bank of America and Citibank, both banks have the exact same data and then they have to reconcile with each other. If it's a shared ledger, you're massively streamlining the back office operations because there's one golden source of truth. And that can be applied to money, it can be applied to securities as well. We are seeing incredible experimentation with Tradify institution, traditional finance institutions. Now BlackRock just tokenized a money market fund and announced a bridge to USDC. So now that can in theory be transacted outside of the banking system in a US dollar cash equivalent, we'll see how long regulators allow that to persist. But it gives you a sense of where, just how far some of these large institutions intend to take this.
Kyle Campbell (03:55):
Right. And I'm glad you mentioned regulation. That is sort of the main topic of the day, if you will. And I think it's maybe helpful to kind of, I guess, recap what's gone on in the space over the past few years. Obviously 2022, there was a lot of discussion in Washington about regulating stable coins, trying to find the right home for regulation of crypto, broadly trying to categorize it. And it wasn't necessarily clear what direction that policy was going to go, but it did. It was something that seemed like it was building towards something until late 2022, a number of very high profile blowups in and around the crypto space, FTX being sort of the most notable. And of course the repercussions being felt on the banking system in the month that followed 2023 obviously started off with the president's or the White House statement around digital assets, a number of not hard regulations, but policy statements by agencies, which we'll get into a little bit more. But after that, it seemed to kind of go on the back burner until now. We have here in 2024, sort of a renewed interest from Congress in trying to get some stable coin bills advanced. And we've got a proposal in the Senate from Lamis and Gillibrand and then progress being made in the house from what I understand. Yes. So how have things changed, I guess, from 2022 at that critical moment of failures and disruption in the space to now? And how do you see the regulatory response? How have you seen it, I guess coalesce?
Caitlin Long (05:49):
Well, there has clearly been a burn it all down approach from the regulators, particularly the political appointee level of the regulators in Washington dc. And I think the reality, to your point, the fact that it's coming back on the regulatory front burner is evidence of the fact that they finally realize it's not going away. And there has to be some reconciliation here of the fact that more and more of this activity is leaving the traditional financial system. We're coming into a bull market in Bitcoin. Historically, there is a cycle to Bitcoin that during having years, you tend to have a big bull market that starts about six months after the having, which would be sometime around the presidential election this year.
Kyle Campbell (06:38):
And just a having is when the amount of Bitcoin that is produced or able to be produced is cut in half. Correct. Because it mechanically reduces by half every so many years until it's no longer made.
Caitlin Long (06:48):
Yes, thank you. Thank you for pointing that out. And we just had one of those. And so if past is prologue and there's good reason to believe that it is because bitcoin becomes more scarce. So there's a fundamental reason. It therefore tends to get into bull markets about six months later, and that is going to ultimately plan to the election because we just have more and more Americans, especially younger Americans, more than half have engaged in crypto transactions. It definitely skews younger from an age perspective, but of course you don't have 20 somethings in Congress. So the ones who are making the rules are typically their parents and maybe even grandparents who might not have understood it as well. But it's definitely back on the front burner to your point. And it's not surprising that stable coins are the first place where something's likely to happen because stable coins are just a new version of US dollars. And so that directly comes into play with the banking system.
Kyle Campbell (07:53):
Right. And for those who aren't necessarily familiar with the machinations of a stable coin, it is a tokenized version of either dollar based or dollar equivalent assets. Is that a fair description?
Caitlin Long (08:10):
Yes, it is.
Kyle Campbell (08:11):
Okay. And as for this bull market you're talking about, are there, I guess risks involved or potential risks that you could see from going into a period such as this without maybe having an adequate regulatory framework? Or to your point about trying to bring this into the more traditional banking space of not having it in that open daylight of regulatory oversight?
Caitlin Long (08:38):
Yes, absolutely. Because you get speculators that come into the market, new users, and from a market surveillance perspective, if they're doing it peer-to-peer or they're using decentralized exchanges, then there is no surveillance. Obviously, depending upon which blockchain they use, they can trace the public address on the blockchain. And ultimately if there's a public address, you can probably trace it to an internet protocol address. That's how, for example, in the Silk Road, the FBI was able to determine who was behind the Silk Road and make the arrest. It's not anonymous, it's sued anonymous because you can always trace it to a public address and ultimately trace that to an IP address and an internet protocol address. So yes, it's an interesting challenge because I think the regulators in Washington wanted this all to go away, hoped that it would now are recognizing that it hasn't. And so now the question becomes from a policy perspective, given that it's just code computers can run code, you can't stop a computer from running code, then what's the real policy goal?
(09:48):
If it's not possible to ban it, then should we bring it into the so-called regulatory perimeter and subject it to the same rules as the rest of the financial system? And increasingly we're starting to see a bipartisan consensus that the answer to that is yes, with regard to stable coins, obviously the ETF, the Bitcoin ETF was introduced earlier this year as well. That was forced in effect by a court decision. The SEC didn't want to do that, but ultimately approved the Bitcoin ETFs. And now there are a dozen or so Bitcoin ETFs, and it's been by far the most successful ETF launch in stock market history.
Kyle Campbell (10:30):
Right. So from a fundamental question, when you look at trying to bring crypto into the regulatory framework, I think some might say, well, the point of crypto was to be decentralized, was to be pseudonym, to be peer to peer and avoid the centralized structure of banks. How do you bring it within the fold and treat it the same as banking type activity without just turning it into regular banking activity?
Caitlin Long (11:05):
Well, that's a good question. Ultimately, there has to be a way to get into and out of the traditional system into the new version of financial instruments. And so the bridge between the two is really important. If you can't move from one to the other, then it is going to cause problems for both. Ultimately. And my North Star has always been don't cause problems for either system. You have to be able to do this very carefully, but you're dealing with two very different animals. The digital asset world settles very quickly and trades 24 7, 365, whereas dollars, as we know, can settle sometimes with an A CH payment, it takes one to three days. With Fedwire, it can go same day, but you can't program it to wait for a transaction. Say somebody buys Bitcoin and then a fed wire gets triggered. You can't program it that way.
(12:02):
It's not programmable. So even though it goes same day, there's still going to be a mismatch between when a Bitcoin transaction settles and when a dollar settles. So somebody has to handle those mismatch risks, and it's easy to do if you set about to do it. But what's ironic about the way the regulators have approached this sector is by trying to kill it all, they've actually stopped some of the risk management techniques that would've taken some of those risks out of the system from the mismatch in US dollar settlement versus say, Bitcoin settlement. And now that we have Bitcoin ETFs, the volume of US dollar to Bitcoin transactions has spiked, and we have no risk management tools because the regulators shut them down. And so it's literally cutting off one's nose, spite one's face. And I'm hoping that the regulators see the light of day.
(12:59):
I've warned directly as recently as two weeks ago to the Fed about some of these very risks that are in the banking system, and they do need to be thinking about them. Even though these markets are quite small, they're big enough to cause problems now, especially with the Bitcoin ETFs, and most of the banks that are involved with the Bitcoin ETFs settling and handling the US dollar transactions are the very largest banks. So you're right into the core of the financial system. It's not talking about banks that were relatively small like Silver Gate and Signature. Those were not systemic. But the banks that are involved with the Bitcoin ETFs are the big names.
Kyle Campbell (13:38):
Right, right. That gets into their securities and market making functions as opposed to just sort of clearing and whatever the networks that those smaller banks were operating. It's a different ballgame, as you say. Yes. So what do you think has been the sort repercussion within the banking space in terms of this approach that regulators have taken, the posture, I guess you might say, has that had a meaningful impact on the number of banks and the types of banks that are willing to engage in this space? And what do you think the ramifications of that have been?
Caitlin Long (14:18):
Oh, yes, definitely. It's not just crypto, it's also FinTech more broadly, but there have been so many enforcement actions taken against the banks that service the financial technology industry broadly, including crypto. Conrad Alt from Claros Group had some very interesting data that in the first quarter, the F FDAs disclosed enforcement actions were 50% attributable to banks serving the FinTech industry, whereas only 3% of the banks serve the FinTech industry. So 50% of the enforcement activity was targeted at those 3% of banks. It's very obvious from the data what's happening. So the vast majority of banks are retrenching, and we've seen it. We've seen it in our partner banks. We see it with customers who are having their accounts suddenly closed running to us trying to open a new account on short notice. Yes, there is clearly a concerted effort behind the scenes that in banking, as you know, they never announced these things. You just have to see it in the indirect ways, but we certainly see it from what we're experiencing ourselves on our banking partners side as well as our customers.
Kyle Campbell (15:29):
For those bankers out there who maybe were considering this and are now not, or maybe were in the space and aren't, again, why do you think it's worth their time to take a second look at crypto and is it something that you think that a large number of banks can, or do you really have to be a specialist to be able to operate in this space?
Caitlin Long (15:53):
Well, I would argue from a safety and Sounders perspective, you should be a specialist. Because what Silver Gate and Signature taught us, and to some extent Silicon Valley Bank generally as well, is that when you have hot money deposits that can be withdrawn in the span of hours, you cannot engage in maturity transformation. So it was obvious to me, and I warned the Fed months before Silver Gate and signature failed, that there were going to be bank runs there because they had 10 cents in cash against demand deposits that could be withdrawn in the span of hours. And that math just doesn't work. If you've got hot money deposits that could be withdrawn in the span of hours, you need to be sitting in cash and not doing maturity transformation or the traditional lending. But I will say ironically, that the Fed called that business model unsafe and unsound in custodian's case, the world has come around since then.
(16:44):
We were arguably just too early because now the Bank of England is requiring that very business model for banks that service the stable coin issuers. And the same is true in the proposed house and Senate bills for stable coin issuers in the us they have to be segregated standalone banks. So they've moved away, actually polar opposite of the original president's working group recommendation on stable coins, which is that only the traditional insured banks that engage in lending work to issue stable coins. The regulators have now woken up and realized that is an unstable business model. And so now Congress is moving in the direction of ring-fenced, standalone banks. They can be subsidiaries, but they have to hold a hundred percent cash so that if there is a bank run, they survive it.
Kyle Campbell (17:28):
Right. Getting into those pieces of legislation, what are, I guess, is that the biggest change that you've seen between the current iteration of those bills and what was put out in 2022? Is it that focus on specialization or are there other sort of developments that you think are critical? That's
Caitlin Long (17:50):
The biggest one. And like I said, it's been codified, right. So much of what the Fed said about custodial back in January, 2023 is going to be overridden by Congress recognizing that trying to marry a traditional fractional reserve lending banking model with something that moves as fast as digital assets is a recipe for bank runs, and it's not stable. So that's why they created the standalone specialists. But what's also interesting is in those bills, there's a provision for the state chartered entities, including the Wyoming Special Purpose Depository institutions and the New York Limited Purpose Trust companies that have issued stable coins already, so that there's a transition provision for those stable coin issuers to get into the regulatory perimeter. I believe a year in the Senate, we'll see what ultimately comes out of the conference committee if this bill does pass. But the point is that the existing issuers have to be given time so that the incumbent banks can't leapfrog them.
(18:57):
And back to your earlier question, the other thing that I've noticed is that the very, very large banks, so you asked about the advice to bankers, the very, very large banks have never given up any of this. And here's the irony is that the pressure of the regionals and community banks that's been put on them by regulators has caused so many to exit, but the big banks just kept right on going. When the regulatory wins shift, the big banks are going to be better positioned. And so yet again, the big banks are going to win relative to the regionals and the community banks, and that's not right.
Kyle Campbell (19:31):
Right, right. I think the biggest concern, at least from the mouth of regulators, it seems to be money laundering because these are peer-to-peer transactions. It's not the same as someone having a bank account when they're transacting in crypto. There seems to be a view that this is a fundamental component, and others have made that argument as well that there's always going to be an element of that. Does the current regulatory framework do enough to, I guess, how do you see it approaching this topic of money laundering and what do you think needs to be done to, I guess, put the crypto space on the same footing as banking? Or can that be done?
Caitlin Long (20:19):
Oh, it absolutely can be. And the first thing that needs to happen is the F-F-I-E-C exam manual has to be updated. Stable coins have been around for 10 years and it hasn't been updated. We've obviously, the custodial application should have precipitated and updated that Wyoming went through with Promontory Group and created a 752 page supervisory exam manual for BSA for digital assets. But the federal bank regulators haven't done that yet. And frankly, it's their job. They should have done that. And that was one of the biggest impediments to custodian's application was that there was no federal supervisory exam manual for Bank Secrecy Act, and it still doesn't exist 15 months later. So that's going to be a big hurdle. But stepping back, if the goal of regulators is to reduce illicit finance, then pushing all of this activity into the dark web actually does not achieve their goal.
(21:17):
If their goal really is to get more is to have as much of this activity in lit markets and outside of dark markets, they should follow the model that telecom followed when voiceover internet protocol came about. You could do peer-to-peer calls on tour using the command line interface, but most software developers who know how to do that don't even do that. Why they use a phone from Verizon or T-Mobile or at and t because the user experience is very good and the security is very good. Well, that's what I would call the lit markets for voice telephony, the dark markets, you could do that over tour. The problem is that it's a lot harder for law enforcement to monitor peer-to-peer phone calls made over voice internet protocol on tour, so people voluntarily went into lit markets. If the real goal is to reduce illicit finance, put it all voluntarily into the traditional financial system, and I find so hypocritical, so many of the comments of federal bank regulators, they want everybody to come into the regulatory perimeter. And when those of us try and we're turned away, and then they complain about all this activity happening outside of the bank regulatory perimeter, well, they're going to have to deal with this at some point, and I think Congress will ultimately force them to do it.
Kyle Campbell (22:43):
Got it. Got it. That is an interesting parallel between the telecom industry and banking, and I think it probably highlights the degree to which this is a digitization transformation in both cases, is that
Caitlin Long (23:00):
Absolutely. It's all data, so a packet of information that travels around the internet, the computers don't know whether it's financial data or voice data. I mean, it's using different protocols of course, but these are the base protocols of the internet, of which Bitcoin is one for transferring value. I believe with the AI revolution that digitally native money is going to be the money of ai. That's not a US dollar issued by a bank through a CH or Fedwire. It has to be digitally native. And so it's just going to force the entire financial system in this direction, and regulators are going to have to cross this bridge in other countries. They have to be fair, the US is really now quite far behind, especially the Middle East and in places like Singapore, which have embraced this new technology, and we're going to have to be playing catch up when the regulatory wins finally do change. Okay,
Kyle Campbell (24:02):
So this is an election year, so maybe something to kind of finish up on is the political constituency for crypto. I mean, we saw, I think, again, going back to 2022, more of a, I guess a robust movement by some politicians to say, this is something that we need to move forward on some saying that we need to block this on. Again, it's starting to revamp a little bit, but how do you see this falling along partisan lines, and how do you think that the other dynamics that are going on politically right now are going to feed into the lawmakers that are ultimately dealing with this issue in 2025?
Caitlin Long (24:46):
What's so interesting about this issue is it creates strange bedfellows. So you see Loomis and Gillibrand who normally wouldn't be voting on very many things together, working together with the Senate version of the Stablecoin Bill. You're seeing similar things happening with sort of strange bedfellows in the house as well. Clearly right now, the Warren Camp is in charge, the progressive Democrats who do have the strategy of burn it all down, there's some debate as to what's really driving that. Do they just want to make the big banks bigger, or are they trying to clear the field for a central bank digital currency, which Warren herself has espoused, but that's not where the moderate Democrats are. The moderate Democrats are more in the camp of let's regulate this. And so you see the partnerships with Senators, Gillibrand and Lamis from both sides of the aisle, New York and Wyoming.
(25:35):
They could blue state, red state, large state, small state, strange bedfellows, and I think that that's going to happen here as well. One of the interesting questions is on the presidential side, is this going to matter? Biden very clearly has made a huge push against the crypto community, but 61% of American crypto owners voted for him in the last election. And the interesting question, they're doubling down on it very clearly. We've seen a big crackdown in the last couple of weeks, even another big crackdown, and you're seeing it in all the regulatory activities from the various financial regulators in DC just in the last week, a huge amount of activity. So there's clearly a big crackdown coming again right into an election. And that demographic of the younger voter is who the Biden Presidential campaign is targeting. So I'm clearly putting their chips on the anti crypto army of Elizabeth Warren right now.
(26:35):
Trump has not sought out a positive view on this yet. The only one of the three presidential candidates who has definitively come out positively as RFK, but it'll be interesting to see what Trump does. As you know, he and Melania issued NFTs, and so they've been involved with Ethereum in a small way, but he hasn't come out and really made this an issue. I have a sense that it might become one, because it's one of the places where going after that, again, younger demographic, and again, 61% voted for Biden in the last election is going to be, we're big enough to swing an election in the close states.
Kyle Campbell (27:15):
In the close states. Sure. Yeah. I mean, a lot can happen in six months as well, so we'll have to stay tuned and see what comes. But Caitlin, thanks so much again for taking the time and engaging this conversation. I really appreciate it.
Caitlin Long (27:28):
Thank you, and thanks for having me in this wonderful setting. You have a great office here. Okay,
Kyle Campbell (27:32):
Great. Yes. Keep that in mind if anyone else thinking about leaders in the future. But yes, appreciate that and thank you all for tuning in. I'm Kyle Campbell for American Banker, and we'll catch you next time.
