Court Affirms Fed's Power to Bar Crypto Banks Over Systemic Risk

A federal appeals court has upheld the Federal Reserve's decision to deny Custodia Bank access to a master account, reinforcing the central bank's authority to reject applications from crypto-focused institutions on grounds of systemic risk, according to a CoinDesk report. The 10th Circuit Court of Appeals ruled 2–1 on Friday, affirming a lower court's 2024 decision and closing a key legal front in Custodia's five-year battle to integrate digital asset banking into the U.S. financial system.

Custodia, a Wyoming-based special purpose depository institution (SPDI) founded by former Wall Street executive Caitlin Long, argued that the Fed's refusal to grant its application violated statutory language requiring payment services to be available to all eligible depository institutions. The bank's lawsuit, initially filed in 2022 over alleged delays in processing its application, later pivoted to challenge the Fed's authority to deny the account outright, as detailed in a TradingView report. However, the appeals court rejected this argument, stating that the Fed retains "discretion to reject master account access requests from eligible entities" to safeguard financial stability.

The ruling aligns with the Federal Reserve's stance that Custodia's crypto-centric model poses risks inconsistent with "safe and sound banking practices." The Kansas City Fed, which evaluated the application, cited concerns over volatility, regulatory compliance, and integration challenges inherent to digital assets, as noted in a Decrypt report. Master accounts, which provide direct access to the Fed's payment rails, are critical for national operations and currently held by no crypto-focused banks. Custodia, operating under a Wyoming SPDI charter, must rely on intermediary banks for Fed services, a limitation it has long contested, according to a CryptoTimes report.

The decision included a sharp dissent from Judge Timothy Tymkovich, a George W. Bush appointee, who argued that the Fed's statutes mandate access for eligible institutions. "This case comes clothed in 21st Century terms: cryptocurrency, digital assets, instant wire transfers, and master accounts," Tymkovich wrote. "But there is nothing new about this issue." His critique centered on statutory interpretation rather than policy, emphasizing that the Fed's discretion should not override clear legislative language, as reported by Cointelegraph.

Custodia has indicated it may seek a rehearing, citing the dissent and a related ruling in the Ninth Circuit that could create a jurisdictional split. The bank also hinted at leveraging potential shifts in Fed leadership, as incoming chairs aligned with the Biden administration may adopt a more crypto-friendly stance. Fed Governor Christopher Waller recently proposed expedited "skinny" master accounts for innovation-driven banks, signaling possible regulatory evolution, a proposal reported by Decrypt.

The ruling underscores the Fed's cautious approach to crypto integration, even as the industry matures. With no crypto bank securing a master account despite eligibility, the decision reflects broader concerns over systemic risk and regulatory clarity. Custodia's founder, Caitlin Long, called the dissent "the next best thing" to a win, leaving the door open for further legal or policy-driven advancements, according to Cointelegraph.