The Pomp Podcast - #1021 Caitlin Long On Building A New Bank That Doesn’t Rely On Leverage & Lending

Starting point is 00:00:00 What's up, everyone? This is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Now let's kick this thing off. Caitlin Long is the founder and CEO of Custodia Bank. In this conversation, we talk about Bitcoin, market cycles, leverage, rehypothecation, underwriting risk, the Federal Reserve, and exactly how these crypto banks plan to interact with and work with the legacy financial system. I really enjoyed this conversation with Caitlin and I hope you guys enjoy it as well. Before we get into this episode though, I first want to talk about our sponsors. This episode is brought to you by FTX US. FTX.US is the safe, regulated way to buy and sell Bitcoin and other digital assets.

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Starting point is 00:03:37 Let's start off with the multi-billion dollar question. Bitcoin and leverage. Are they friends or are they enemies? How do you look at Bitcoin and leverage? You've been doing this for much longer even than I have. What's your take on all the leverage in the system and kind of how we should expect this to play out? It's bad.

Starting point is 00:03:57 They're enemies. Bitcoin doesn't have yield inherently. So all this yield chasing that's happened in the last few years, especially since the last four-year bull cycle, so really beginning in 2017, is when the leverage started coming in and people started to create financial products with yield on Bitcoin. Bitcoin itself doesn't have any yield. It doesn't need any yield. Its inflation rate right now is 1.75% compared to CPI of 8.6%.

Starting point is 00:04:27 So you come out ahead on an inflation-adjusted basis just by holding it. And of course, as you know, and most of your listeners know, that that inflation rate gets cut in half every four years, and we're less than two years from that inflation rate getting cut in half from 1.75% now to 0.88% in 2024, and then 0.44% in 2028, et cetera, et cetera. So when you start to think about this leverage in the system and kind of inflation, my general read is that the undisciplined monetary and fiscal policy has, I don't know, gamified financial markets. It's caused very short-term thinking. It's led to this kind of casino effect, not just in stocks but in other asset classes as well. Is leverage a byproduct of that?

Starting point is 00:05:18 And people basically are playing a game, and so they say, if I'm going to play, let me really play. And then that leads to so much leverage being built up. Oh, absolutely. Yes, this is not unique to crypto. Of course, crypto just happened to be an easy place for folks to do it over the last few years. But yes, there's too much leverage in TradFi as well. And just like we don't know how much leverage there is in the crypto universe because it's

Starting point is 00:05:41 impossible to measure, we don't know how much leverage there is in TradFi as well. The euro-dollar markets, I've done a lot of work, for example, with Dr. Singh from the IMF. He's known for having the best estimates of leverage in the euro-dollar market. And there's so much opacity that you don't, he can only update his estimates once a year. And it's based on year-end financial statements. And we know how much balance sheet window dressing gets done to financial institutions' balance sheets right before they do a big annual report. So there's a lot more leverage out there, I think, than most folks know. And it is a function of debt being artificially cheap. But as you and I talked yesterday when we were prepping for this, I think we've undergone a regime change. It was clearly the case that there was artificially cheap debt out there. And for the last 30 plus years, the incentive was to lever up and buy assets that were going

Starting point is 00:06:41 to go down by less than the currency was going to go down in value. And I think we may have already incurred a regime change. And that's why you're seeing a lot of bankruptcies of companies that played that game, including and especially in crypto, which is kind of leading TradFi in terms of in terms of the correction. So when you start to think about the last two years, you can see that obviously Wall Street came in in a major way. We saw Paul Tudor Jones, we saw Stanley Druckenmiller, two of the widely considered best investors in the world, talk about Bitcoin as an inflation hedge in Q3, Q4 of 2020. There was no inflation at the time, or at least not to the degree that we eventually saw. And they went ahead, they made the move. Once they did that,

Starting point is 00:07:26 my understanding or evaluation is that they removed all career risk for anyone on Wall Street to begin to allocate to Bitcoin. So we saw obviously public companies doing it. We saw wall street hedge funds we saw private investors family offices like it was game on bitcoin went from ten thousand dollars uh or so to about sixty thousand dollars uh by march of uh 2021 and there's a whole bunch of structural things as to why that happened including gbtc arbitrage and many other factors but there was a financialization it seemed like that happened in the asset yep if we then fast forward a year later october november even in december of 2021 many of those wall street investors were still holding bitcoin and the fed changed its tune

Starting point is 00:08:12 and it seemed like bitcoin was the riskiest asset in their portfolio and so when they went risk off bitcoin was you know sent to the altar and sacrificed to some degree right how do you think about wall street hedge funds financial institutions and bitcoin and like is it a part of the game and we should expect it to continue or is it bad and actually we don't want this to continue? It's bad because the leverage games are bad. The long only players that looked at it as a true inflation hedge have been good for it. But the hedge fund leverage games, that's what's been bad. And of course, it's not trading. It hasn't traded like an inflation hedge. That doesn't mean that it won't. It's just traded, as you correctly point out, as a more high beta play on the

Starting point is 00:09:03 industry right now. But I'd like to go back, because you mentioned something that I think is really important, which is the GBTC ARB. You've got to realize that that was created by the SEC. The SEC sat for six years with one and only one way for folks to be able to get exposure in their brokerage accounts to Bitcoin, and that was through the closed-end fund structure for Grayscale, GBTC. And it took them six years to approve a competing product. Well, you know very well, you've talked about it on your show before, the structural issues with closed-end funds. And they traded premiums when demand exceeds supply.

Starting point is 00:09:44 OK, now, in that case, I went back and looked just to kind of do a retrospective on this. The premium, it peaked at more than double the price of Bitcoin at its peak. And it was pretty consistently a hefty premium until last year, at which point it went to a discount. And last I looked, it was at a 34% discount. So you've had a wild roller coaster that has been rocketed along by the SEC because there was no competing product that could satisfy that demand. And as a result, the premium just went to stratospheric levels. Now, how does that play into the hedge fund leverage game? That attracted a lot of hedge funds who wanted to come in to play that sure thing trade, to capture that risk-free arbitrage of collecting that premium.

Starting point is 00:10:35 And again, it was at one point more than double the price of Bitcoin, right? That's a hefty premium for a risk-free trade. And what ended up happening is they put a lot of leverage on, and then they played the next big thing, which was the contango in the futures market. And you could go offshore and get 125 to 1 leverage. You still can get 20 to 1 leverage very easily offshore, not onshore, but offshore. And then when that started to collapse, where did they go? They went to the anchor protocol, which was a Ponzi scheme. And when that collapsed, the whole thing ended up coming unwound. But all of this was foreseeable because Bitcoin itself doesn't have a yield and it shouldn't be leveraged. It's incompatible with leverage.

Starting point is 00:11:19 And why is that? Because no one's ever going to make more than 21 million of these. And so I always credit Trace Mayer calling Bitcoin the apex predator of finance. There is no one to bail it out. And at some point, all this leverage is going to be flushed out of the market. And I think that's a healthy thing. But you got to realize that some of this leverage was regulator created. When you think about their attempts to convert GBTC to the ETF, we have the Bitcoin futures, we have the short Bitcoin futures ETF. Is that going to happen? Like, will we get the ETF conversion? Well, I don't know, to be honest, right? The SEC has kicked that can for so many years. And now, given everything that's happened, what I've heard from folks in Washington, D.C., is that everyone thinks that because crypto is finally collapsing, that they don't have to make any decisions. I think that's not the case at all. In fact, actually, we're probably going to see some things break open. But one of the things that the Grayscale folks have correctly been saying is that the closed-end fund structure, where you can see these wild premiums or deep discounts, like we've seen today, the wild premiums were in past years that brought all these leveraged hedge funds in, that that is inherent to the closed-end fund structure. and the ETF structure is a relief valve for some of that. But the biggest issue the SEC has, which they're not wrong about, is all the manipulation in the spot market. And they're trying to get the exchanges to crack down on that. But I think we all know that this is not a market

Starting point is 00:12:54 that's got watchdogs and that there is manipulation. And that's a problem. And if the SEC sticks to that forever. There may not be an ETF. We just don't know. So when we start to consider the Federal Reserve's actions, they are going to continue to raise interest rates. They are going to conduct quantitative tightening. Forget for a second what the regulators do. We have an environment where Bitcoin has crashed aggressively. There are other asset prices that are crashing as well. There's a risk of potentially going into a recession. What is your expectation for the Fed to do given asset prices crashing, inflation so at 8.6 percent, their commitment to destroying demand, midterm elections on the horizon? Like there is a very complex kind of, you know,

Starting point is 00:13:43 board game at play here. What do you think happens? Well, I think you nailed it. It's very complex. And this is probably you see a lot of the experienced investors, some of us grizzled folks with proverbial gray hair, who've been around a long time, I started my career in the night in the right into the 1994 bond market crash. And so and I remember the 1987 stock market crash, I wasn't working at that time. But, but those of us who've been around, I mean, literally, there hasn't been a bond, a true bond market correction since 1994. Right? Most of the people in the markets today have not experienced that. And so it's the folks that have been around in those environments that are out there saying, my gosh, this is an unbelievably complex market in

Starting point is 00:14:29 which to manage money. And, you know, we saw a number of hedge fund managers fold because it's hard. It's really hard. And the macro call is going to drive everything. And we just don't know, you know, the bond market. By the way, I have some sympathy for this whole criticism about the use of the word transitory on inflation, because if you go back and look at what the bond market was saying, you know, 12, 18 months ago, the bond market was saying that the inflation was going to be transitory. The bond market was wrong. And the bond market is still saying that the Fed tightening cycle is not going to be as long as the economists are saying that it's going to be. Which one's right? The bond market's already been wrong once on a big call. And we

Starting point is 00:15:21 don't know. I think the honest truth is we don't know. It's a very uncertain environment for sure. So if we start to look at leverage, again, you were talking about kind of a couple of different things there. Outside of Bitcoin, we obviously saw immense leverage. We saw kind of this contagion that's spread through the system. Is there a separation between like the Bitcoin leverage market and maybe I'll call it like the Bitcoin obstacles with the crypto market obstacles, or is this all intertwined and whether Bitcoiners like it or not, Bitcoin will be affected by other maybe sins that occur, you know, outside of the Bitcoin, but still in the crypto market? Oh, it's definitely all intertwined because the leverage is coming in fiat currency. And that's

Starting point is 00:16:10 what's creating the leverage, right? We saw just over the weekend when we saw these huge transactions happening, we saw big prints in some of the stable coins, right? That's fiat. So yeah, the leverage that's coming in is mostly in the form of fiat. Not entirely, of course, because there's clearly leverage in crypto as well. But look, I've been watching what's happening with the yen. I've been watching what's happening with the euro. The yen itself, my gosh, that's been a multi-decade correction that's taken place in the yen and i don't see a lot of people writing about it um but but you know some some some folks have called that that there there was a regime change in the yen the yen having been the carry trade currency of so many

Starting point is 00:16:55 hedge funds right that's again these leveraged sure thing trades that work for years that suddenly reverse there are big losses out there somewhere and uh and and those trade those trades just don't work anymore. And now we've seen a big reversal, especially in the yen. I saw an interesting headline about the ECB's emergency meeting last week, that a lot of folks in the markets didn't recognize that there was an emergency until the ECB called an emergency meeting. But that's a fascinating thing. Having been a student of history, one of the interesting things about the Federal Reserve that very few people know, and it's connected to the structure the ECB, is that originally when the Fed was created, the 12 different regional reserve banks

Starting point is 00:17:38 each had their own monetary policy and each set their own interest rates and conducted their own open market operations. It wasn't until 1935 that that was centralized into D.C. with the FOMC to set interest rates across the whole U.S. And then the open market operations are conducted through the New York Fed only. Now, what Europe is trying to do, they came out with that centralized model, right? But there are 19 different states, countries in the EU that have clearly very different interest rate needs and very different bond market dynamics. And the ECB is really fighting against that because the market doesn't want there to be one monetary policy and one interest rate in Europe. And so we've just seen these pendulums swing back and forth.

Starting point is 00:18:26 post-depression in the US, we centralized it all into one place. With ECB, they centralized it in one place to begin with, and now the market is putting pressure on them to fragment it. It's just going to be fascinating. Again, we're in a really unprecedented moment in financial history, for sure. Obviously, there's a relative nature to a lot of these central bank decisions. We saw the Federal Reserve back in November, December talk tough, hey, we're going to conduct some sort of financial tightening and we need to address inflation. The ECB at the time was saying that actually they were going to stay with negative interest rates. They kind of were going to break from the Fed. They now have reversed course and now talking about zero

Starting point is 00:19:08 percent interest rates. And then they did have this emergency meeting. Is that a sign that all central banks, regardless of kind of their initial commentary, they're going to have to act in unison here and we should expect, kind of follow the leader in various decisions, you know, for the tightening, but then also in the pivot as well? That's another good question. I don't have, I don't formally forecast. And so I don't, I don't have the, I'm not a macro maven, so to speak. I just, you know, armchair macro person who spent a lot of time looking into all this and, you know, understanding the history of it. And, but your, your question is a very good one, which is, right now, the dollar is spiking as a result of the collapse of some of these other currencies,

Starting point is 00:19:53 right? And strong dollar environments tend to be basically short covering because of the way the euro dollar market works. It's a reference to the famous Triffin dilemma of having a fiat currency be a reserve currency. You basically end up with current account deficits in the reserve currency issuers country. And that basically creates a big short position in that currency. And so when a lot of folks look at the Fed and say, oh, my gosh, there's been so much money printed, it's a head scratcher for the fact that the dollar has actually spiked, not crashed relative to expectations, right? And so it's a head fake, but you know why it's happening, because there's basically this natural short in the position of the reserve currency. And when we get into these kind of

Starting point is 00:20:43 environments, that short starts to get covered. And you start to get liquidity problems, especially in the repo market, the euro dollar markets. And we're seeing that yet again. But it does coincide with a spike in the dollar. And so this is where a lot of the folks who called for the end of the dollar dating back to 1974, when we first in the US went off the gold standard, a lot of those folks were wrong. And it's because of the mechanics of the fact that this is a global system and you can't look at it just on one country's balance sheet alone. It's very interconnected. So back to answer your question, will they need to be coordinated? Even if they're not coordinated, they are coordinated indirectly because the markets are global and they are all

Starting point is 00:21:34 connected like it or not. Talk to us about Custodia and what you guys are doing there in terms of building a bank that isn't necessarily based on all of this leverage. Yeah, we really are different. The Wyoming Special Purpose Depository Institution Charter is a non-lending charter. And it's designed for custody of digital assets. So it's a depository institution that can handle U.S. dollar transactions like Fedwire and ACH in a way that fintechs can't because it is a depository institution, which makes it eligible to have a Federal Reserve master account and clear those dollar payments directly at the Fed. But in addition to that, it's authorized that the Wyoming special purpose depository institutions are authorized to provide custody services for

Starting point is 00:22:20 digital assets. So to be clear, the U.S. dollar piece is a non-lending, just essentially a transactional-based charter because it's non-lending. And then it can provide digital asset custody, no digital assets on balance sheet, everything off balance sheet. And because it's a non-lending bank and because of the capital requirements, we put out a tweet yesterday at Custodia reminding folks that, yes, we really did propose to the Fed to hold $1.08 in cash in our Fedmaster account, if and when we get it, for every dollar of customer deposits in the first three years of operation. So a lot of banks run on, they'll take your cash and turn around and lend it, playing the yield curve, taking on interest rate risk and credit risk. But that is

Starting point is 00:23:10 the opposite of our business model. And so you're right to point out, we're the antithesis of all this leverage. We're designed to be solvent. It's designed not to allow lending of U.S. dollars on balance sheet, but also know what's called rehypothecation of digital assets as well, so that it's designed to not be leveraged and be the anti-leverage play in this industry. Clearly, though, we're not operating yet. We have no customers, but stay tuned because we're getting pretty close to apply for what's called our certificate of authority to operate. when this bank ends up becoming the standard, let's say that, right? And obviously I'm betting I'm an investor in the business. I believe that this is a good idea. What changes in the legacy

Starting point is 00:23:59 financial system? Well, this bank is designed to be a transactional bank. It's not designed to be a bank that earns a spread. Why that? I mean, think back to the movie, It's a Wonderful Life, where there's a bank run and all the locals come and say, I want my money back. And the banker has to say, well, it's in Johnny's house and it's in Katie's car because the bank turned around and took your deposit and lent it out. And therefore, it doesn't have the liquidity to pay you back on demand. And so that's a very different business model than this business model. This business model is designed to be a fee-based business model, not a spread-based business model where the bank is earning a yield on the loan and then turning around and paying the depositors less

Starting point is 00:24:44 on their cash. The Wyoming Special Purpose Depository Institution Charter is designed to be a fee-based business model. And in that regard, it looks a lot more like the financial technology companies that don't lend. They're transactional-based businesses that provide faster settling payments. And that's ultimately the problem that we're trying to solve, is making payments easier for our customers and doing it in a way where software can be written with the bank on the back end. There aren't very many banks that provide APIs

Starting point is 00:25:20 to allow customers to write their own software, to direct their own payments, and that's what we're building here. How does self-custody play into this? So obviously self-custody in Bitcoin is a huge thing, not your keys, not your coin. You and I have talked about in the past many, many times proof of reserves, all of that. How do you see the idea of self-custody

Starting point is 00:25:40 and an asset like Bitcoin playing into a bank and playing into a financial system? Well, you see CEOs of companies that have these Wyoming special purpose depository institution charters like Kraken and WDT Financial and Custodia talking about how we're providing custody services, but we also constantly say, not your keys, not your coins. And in fact, Jesse Powell at Kraken will actually say, don't custody your coins with us. Get them off the platform. And so, yes, we're providing the service, but while it's at custodia, just like at Kraken, encouraging people not to use it precisely because self-custody is the only way you own real on-chain Bitcoin. And the only way that you know that your counterparty is not creating more

Starting point is 00:26:30 claims to Bitcoin than they have Bitcoin in inventory. Now, proof of reserves, which Kraken has already voluntarily done on its Bitcoin position, and then it is required under the Wyoming. Well, it's a way we can satisfy our audit requirement under the Wyoming charter. Again, that's a big differentiator. Boy, if we had had the intermediaries in this sector providing cryptographic proof of reserves, we would have understood that there were insolvent intermediaries out there that were just not bankrupt yet because they were still liquid. And what you started to see in the last couple of weeks is that those insolvent intermediaries have had to either close or get liquidity bailouts just to allow them to fight another

Starting point is 00:27:15 day. But solvent institutions don't need liquidity bailouts. The whole reason why they needed the liquidity bailout is because they were insolvent to begin with. And I love to point out to the Mises structure, which is that in these kind of corrections, all you're doing is revealing the insolvencies that were there all along. Everyone kind of knew they were there, but no one knew exactly which ones and by how much, because there was so much opacity in this industry. And I was out there encouraging institutions to voluntarily disclose their balance sheets. And of course, a couple like

Starting point is 00:27:51 Kraken did, but most did not. And now we're seeing why, because they actually had things to hide and ended up having to close their doors. It's not a surprise to those of us who've been saying, not your keys, not your coins for years. There's a recent tweet from the company's account that said that you all proposed to the Fed to hold $1.08 in a Fedmaster account for every $1 of customer deposits during your first three years of operating with a Fedmaster account. So if I deposit $1, there'll be $1.08 held in that Fedmaster account. Why is that important? And two, how would you actually do that? Well, it gets to this business plan of we're not playing the leverage game, not even taking any credit risk or interest rate risk with

Starting point is 00:28:39 Just basically, literally, backing demand deposits, we've proposed, with 100% cash, but not just 100%, 108% cash. So that extra $0.08 is the company's capital. And we've proposed to the Fed to hold all of that in the first three years in our Fed account. So it gets back to this whole notion of radical solvency, safety, and soundness. This is a non-lending business model, all based on transaction fees, as opposed to playing that, you know, rolling the leverage dice, which we don't think, and of course, under Wyoming law, we're not allowed to, we don't think we should be doing. This industry moves too fast.

Starting point is 00:29:21 Let's step back and talk about the policy reason why. We've seen it, Anthony, in the unwinds of companies in our industry. It literally happened within hours, these bankruptcies. In the traditional financial services industry, you don't see it within hours. You see it at best within days. The regulators may see it coming within weeks or months, but it's never within hours. And in our industry, because digital assets settle so fast, i.e. in minutes, with irreversibility, the bankruptcies can happen incredibly fast.

Starting point is 00:29:58 And so one of the challenges is how do you merge the digital asset industry with the traditional financial services industry in a way that doesn't create safety and soundness problems for the traditional industry? And the OCC acting commissioner, Michael Hsu, made a very interesting speech when we were all down in Miami for the Bitcoin conference, where he talked about the liquidity issues with having traditional financial services industries be involved with digital assets because they settle so fast. In the traditional world, you know, payments settle at best same day, but more likely through the ACH system two to three days later. And we're talking about in

Starting point is 00:30:37 the stablecoin world, the payments settle in minutes. ACH payments are reversible. Stablecoin payments are not. So generally speaking. So we're talking about two very, very different settlement cycles. And you could have an intraday bank run. And because of the fact that the systems in the traditional industry and the liquidity provision has been tailored for the fact that the term structure of the liabilities in the traditional industry is longer, you could have an intraday bank run at a traditional financial institution handling digital assets, and they wouldn't even know it until the next day. And that creates a lot of challenge for prudential regulators. And so I'm glad to see that the big bank regulators are recognizing that there's inherently a liquidity

Starting point is 00:31:27 mismatch with traditional financial institutions getting involved in digital assets. And there's one safe and sound way to do it. And that is the proposal that the Wyoming special purpose depository institutions have, which is don't lend, don't take interest rate or credit risk, just keep it simple and propose to keep all the cash on deposit at the Fed. Now, of course, as you know, the Fed has not approved that proposal, but that is indeed the proposal that we've made, which is the way in which digital assets can be plugged into the traditional financial system in a safe and sound manner without triggering this bank run. And I'll just So Dr. Singh and I from the IMF have done a couple of recent posts on this.

Starting point is 00:32:12 My own thinking has evolved, has hardened on this. I used to think that it was OK to put T-bills behind a stablecoin liability, but T-bills settle trade date plus next day. So even T-bills don't settle same day. And so this issue of if there were a run on a stablecoin issuer like there was on Terra and it collapses within hours, and all that's backing them is T-bills, you could have an intraday collapse. And that's where you really could get spillover risk into the traditional financial system. And the regulators are right to raise that as a concern.

Starting point is 00:32:53 Another part of the Federal Reserve system, or tangentially related, is Fedwire. And Lynn Alden recently tweeted and said, Fedwire performs about 200 million transactions per year, averaging about $5 million per transaction, results in roughly $1 quadrillion in annual gross settlement value. Now, 200 million transactions in Fedwire is an interesting data point, because as Nick Carter pointed out, that's fewer transactions than Bitcoin. Not much. Yeah. And so help me understand, how is it that the system is so important, but actually not nearly as big from like a pure just transaction, you know, aggregate number of transactions? Like that's surprising to me. Right. Well, most payments don't go through Fedwire. It's exactly what you're alluding to. Think about it for your own personal situation. You're probably using ACH for every payment in your life except for your mortgage, right?

Starting point is 00:33:54 When you buy your house that you're using Fedwire for that, it's a high value transfer. And when you're paying your mortgage, you're using ACH. But when the funds are transferred at the time of you purchasing a house or selling a house, that's when you'll use Fedwire. Most people never touch Fedwire because to your point, I hadn't seen that tweet from Lynn, but she's absolutely right. It's a high value payment system where you need to try to get faster settlement. But one of the challenges with Bedwire is that you cannot program it. Even when you fill out a form at your bank online, as opposed to dealing with going into a branch and having it done manually, the form fill is not actually a software-based direction of payment.

Starting point is 00:34:39 It just populates a data field, but the payment is still done manually. And so it's so clear that, you know, this is old technology. Some of these payment technologies that are still in use today in the U.S. are 40 years old. And most of the rest of the world, which has, for example, especially in the U.K., a real time gross settlement system, India does as well, they're just using better payment technology and the U.S. has been behind. There are a lot of reasons for that, but clearly that's going to change.

Starting point is 00:35:09 And one thing I do like to point out is that I think crypto would not have taken off the way that it did had we had better payment technologies in the U.S. Is it a thing where Bitcoin and stable coins can completely replace this legacy system or will they coincide and coexist for, you know, years and years to come? Well, I do happen to think stable coins will. It's a better payment rail for the U.S. dollar. I agree with Nick Carter that the U.S. dollar stable coins, to the extent that they're embraced, which they have really not been yet, to the extent that they're embraced by the banking system. Again, it has to be done by the banking system because all U.S. dollars ultimately clear through the Fed. So the banking system has to embrace this, and it hasn't yet. All the stable coins that are issued, even the regulated ones that come out of NYDFS, they're not issued by banks.

Starting point is 00:36:02 So Custodia does have a business plan to issue a stablecoin-like instrument in the form of a digital cashier's check that would settle on blockchain rails and therefore settle fast with irreversibility. It's a different payment product than is available in the market today, and it's designed to fit this need for programmable payments that are better, faster, cheaper, and more transparent. But it's obviously not happening yet. So back to answer your question. Yes, I think they can coexist. I think opening these payment technologies to a broader universe of users, i.e. the approved regulated systems users, that is going to extend the U.S. dollar's reign as reserve currency. Do I think Bitcoin long term will end up being a reserve currency? Yes. I think there's a lot of reason to look at it as a reserve currency already today, but on a very small scale. There are multiple reserve currencies. There's not just one. There's a dominant one right now, and that's the US dollar. And the fact that in the stablecoin market, users voted with their feet so that 99% of stablecoin liabilities outstanding are U.S. dollar, that speaks volumes about the power of the U.S. dollar. It's not going anywhere anytime soon, most likely. And I do believe that the technology, it's been resting on its laurels on bad payment technology for decades. And these new payment technologies, I think, will extend it.

Starting point is 00:37:34 We haven't talked yet about FedNow. The Fed is coming out with its own faster payment system. This has been an initiative that's been underway for years. I started reading about Fed now, I believe, in 2014 or 2015. And here we are in 2022. And the latest is that it'll be out next year. But I'm not holding my breath because we haven't seen any of the real details yet. We don't know if these are reversible payments.

Starting point is 00:38:01 We don't know how programmable they're going to be. We don't know if they're going to be as readily and easily usable as stable coins are. We just don't know. And I expect that Custodia will be an active user of FedNow. And so, again, I think these systems can all coexist. It's worth mentioning also, implicit in your question, as you talked about FedWire, that's a high-value transfer system. ACH is the lower-value transfer system.

Starting point is 00:38:30 Those two coexist. There's no reason why stable coins can't coexist with those and FedNow itself can't coexist. I think they will all end up coexisting and being used depending upon what type of payment the user needs the different payments for. If you want a fast settling payment that's not reversible, then you use one of the blockchain systems. If you want reversible, slower settling payments, then ACH, et cetera, et cetera. So I've got, I think, three questions, and then I will refrain from asking any more. I feel like I could ask you a million questions, but I'm going to only ask three more. The first one is, when you look out over the next decade or so, how much progress do you expect to occur for Bitcoin and also for these kind of non-leverage banks like Custodia? What is your kind of viewpoint in terms of if it is a multi-decade journey, how much do you think we can get done in the next 10 years or so?

Starting point is 00:39:28 Oh, yeah, it's definitely a multi-decade journey. And I think stablecoins, you know, the Bitcoin maxis look at stablecoins and say, oh, this is slowing Bitcoin adoption down. Yeah, it's right. They're right. But what it's doing is Bitcoin is not ready to become a true reserve currency just yet because we've got scaling problems. And I'm a big, big fan, as I think you are, in the Lightning Network.

Starting point is 00:39:52 But that's only a couple of years old, and there's not that much value running through it. And there are challenges, a lot of engineering decisions yet to be made in the Lightning Network. So I'm a big fan of it, but it just goes to show you how early we are. And so that's where the low-value payments are going to end up being made using the Bitcoin blockchain is through Lightning. And by the way, if you're a hodler of Bitcoin, that's a place where you can pick up some income if you really want to without taking counterparty risk by providing your Bitcoin into a lightning channel, because you're not giving your Bitcoin to a counterparty if you do that. But needless to say, it's still so small and so nascent. There's a lot of operational risk in doing that. But we're going to get there. So, yes, I think this is a long process. And if we try to make Bitcoin a reserve currency today, it would be a destabilizing transition. And so I think the stablecoin type technologies are going to be helpful in the transition to the more multipolar world where you have more choice in reserve currency. And of course, Bitcoin, I'm a big believer, is going to end up being one of those.

Starting point is 00:41:07 But I'm not making any price predictions or indeed not making any timeline predictions on that because I recognize how early we are and we have a lot of work to do. And so also to your question about the non-lending banks, yes, this is how the payment banks will end up evolving. A lot of fintechs look like that already. the PayPals of the world, the Stripes of the world. They're basically just payment providers. The difference is they're not banks

Starting point is 00:41:37 because they're not what's called a depository institution. They don't take U.S. dollar deposits. They're using a backend bank to clear their U.S. dollar deposits. But I think you're gonna see a merging of that business model and the banking business model that gets it all inside the so-called regulatory umbrella. That's exactly what the Wyoming Special Purpose Depository Institution does. It's a non-lending bank, which looks a lot like a fintech because it's a payment bank, but it's an actual bank regulated as a bank subject to all of the same capital requirements under the prompt corrective action rules, as well as the annual bank supervision and enhanced compliance requirements under the Bank Secrecy Act that only apply to banks.

Starting point is 00:42:24 There's a lot of differences between banks and non-banks, i.e. banks and fintechs. And the Wyoming Special Purpose Depository Institution uses bank regulation, but for the business models that are more geared towards payments and therefore fee-based non-lending business models. My second question is, we've got this self-custody that continues to happen. And if you think of Ledger, who's one of the sponsors of some of our shows, they've got great hardware. But also to your point, I don't think that you or many other people believe that 100% of everyone's assets are going to be put in self-custody forever and you won't be able to easily spend them if you go to the store, right? And so what does that look like, a balance between the self-custody versus maybe what I'll just call transactional funds versus your savings or your longer-term assets? How do you think about the balance of that and maybe what it'll look like moving forward? Well, we're getting better. You point out that the hardware providers, if you look at the evolution of Bitcoin, before we had multisig, there were a lot more hacks than there are today because you had a single point of failure. Well, now we have multi-sig, so you can self-custody without having a single point of failure.

Starting point is 00:43:45 We also then had ledgers and treasurers and cold cards and all the other hardware-based systems that evolved in around 2015-ish is when they started to really come online that made self-custody easier for non-technologists like myself. And it was very intuitive. You just had to teach yourself. It definitely took time. And actually, the recovery seeds were what enabled that technology to take place. And now we're seeing another evolution of that, where you've got software-based multisig

Starting point is 00:44:19 providers that are solving the fact that those hardware devices became a single source of failure. Let's figure out how to use the native multisig of Bitcoin with those hardware providers to get the best of all possible worlds. And there are now companies that are offering self-custody on that. So we've seen a real advancement in making self-custody easy. It's still not easy. We have a long way to go, in my opinion.

Starting point is 00:44:45 But back to answer your question, yes, I've never thought 100% will be self-custodied. And there's one simple reason why. Registered investment advisors under the Investment Advisors Act of 1940 and then mutual fund companies under the Investment Company Act of 1940 are both required to segregate the management of client assets from the custody of client assets. And I don't think that's going to change, nor do I think it should. What that does is it requires segregation into, right now, a third party. Will the SEC end up recognizing some sort of a multi-sig arrangement as de facto third party? That would be the safest way to go. That would be the ideal way to go. But I don't think they

Starting point is 00:45:28 will ever allow an asset manager or a registered investment advisor to be the sole custodian of a customer's assets. There was just too much mischief during the Depression, especially, that caused Congress to enact those laws requiring the segregation of asset management and custody of assets under management. And I don't think that that's ever going to go 100% back. My last question is about being a startup founder right now. Obviously, there is immense chaos, uncertainty. The ground is shifting beneath us, both obviously in Bitcoin and kind of larger crypto market, in the traditional financial system, in the venture market, all of that. uh the two-part question one what's maybe a takeaway from being a startup founder that most people may not be aware of if they're not in that position today like what would surprise them or what is something that you're like man in the last six months this has really changed and then

Starting point is 00:46:25 two is uh eight sleep uh i sleep on every night amazing uh what is your sleep schedule over the last eight to twelve months and has that changed at all as the craziness unfolds well uh i think the biggest surprise is just how tight the labor market has been. And so, in fact, actually, some of what has happened has loosened the labor market. There have been big layoffs of great people in this industry. But it's, boy, we're experiencing the same thing that everybody in all industries are experiencing. There are just more jobs out there than there are people to fill them. And because we were an early part of the correction in our digital asset industry, uh, we're definitely seeing more engineers and more qualified folks on the compliance side,

Starting point is 00:47:14 for example, um, shaking loose. And so we've been able to take advantage of that, uh, sleep schedule. You saw me start laughing. I'm not doing, I'm not sleeping much these days. I, you know, I, I, I'm, I probably work on average 14 to 16 hours a day and seven days a week. Come on, Kayla. Why so little, like there's 24 hours in a day. What are you doing? It's more than that. Yeah. It's you know, it's just the, but that's been in our case, that's been the case really since, since the company got started. We're on such a different cycle though, Anthony, as you know, because we're such a different business. We, we, we knew when we started this bank, it was going to take time. You know, you can set up a, a, a lightly regulated

Starting point is 00:47:56 or non-regulated business in the span of months in this industry. Why is it that Custody has been at this for more than two years, as have all the other Wyoming special purpose depository institutions, because it is a much heavier lift to get a bank started. There's just a lot more process. There's a lot more technology, a lot more testing. You can't kind of shoot first and ask questions later kind of thing in the banking world. A lot of it is permission, not forgiveness. And there's just a lot of process around it. So this is why you see trust companies pop up. They get their charters in the span of a couple of months, they're very lightly capitalized and they don't have all of this process or the compliance requirements of a bank. Huge difference.

Starting point is 00:48:38 And there are no crypto native companies that are banks. The OCC granted trust company charters to three players in this industry, but those are not banks. They don't have the requirements that the Wyoming Special Purpose Depository Institutions have. And that's why they're operating before we are. So we're on such a different cycle. And I'm fine with that because we're building for something. We knew we were never building for this bull market that just ended in retrospect pretty clearly in November. And we always knew we were building for the next one in the four-year cycle. And I think we're going to be deemed, banks like us will be deemed critical infrastructure in the next one because the regulators by then will have made a decision that they want more of this

Starting point is 00:49:24 inside the bank regulatory umbrella, which is exactly where we thought they would end up from the beginning. And it's definitely taken more time for them to conclude that. But pretty clearly, that's where the puck is heading. It's not there today, but it's heading there. Where can we send people to find you on the internet or find out more about Custodia? Custodiabank.com. We are, of course, not operating. Stay tuned. We'll have more information. We're the proverbial tortoise, not the hare, building something really, truly durable and long-term. So that's why we're on such a different cycle. We don't have any customers yet. So stay tuned. And by the way, we will be only serving business customers,

Starting point is 00:50:08 not individuals. The compliance requirements for serving consumers are so much higher, and we've got a big enough lift just to serve businesses. So stay tuned. We'll have announcements coming out about the timing of our launch. And we want to thank you and this whole industry for your support. It's been just a wild ride and so much fun. We're doing something new and different nobody's done before.

Starting point is 00:50:30 And I want to thank especially the Custodia team that has just been great. We've got 31 people who are, everybody's working crazy hours to get this launched and bring this critical infrastructure into our industry in a safe and sound and compliant way. Kaylin, thank you so much for your time. uh anyone who has not taken a look at what you guys are building i highly suggest it

Starting point is 00:50:50 uh i'm a big fan uh i'm an investor in the business and think that uh it's okay if it takes a long time if it's the right thing we'll uh we'll see uh see see how it plays out uh so we'll definitely have to bring you back as you guys make more progress thanks so much love it thanks pomp good to see you all right bye thanks so much for listening to today's episode i really hope you guys enjoyed this one make sure you're subscribed on apple spotify or your favorite podcast player. And if you're looking to try to transition to get a new job in the Bitcoin or crypto industry, we've got you covered. Head over to palmscryptocourse.com. We've developed a curriculum with the top teams across the industry. It's a three week intensive training program with

Starting point is 00:51:28 over 50 events packed into that three week time period. Go to palmscryptocourse.com to learn more and I'll meet you guys for the next episode.

The Pomp Podcast - #1021 Caitlin Long On Building A New Bank That Doesn’t Rely On Leverage & Lending

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