The Pomp Podcast - #548: Caitlin Long on the Federal Reserve Payment Proposal

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 Avanti Bank, a new U.S. bank based in Wyoming that intends to serve the digital asset industry with new products and services that are not currently available in U.S. dollar markets. In this conversation, we discuss the Fed payment system, the OCC trust companies, SPDIs, FDIC insurance, uninsured institutions gaining Fed access, and settlement risk in crypto. I really enjoyed this conversation with Caitlin, and I hope you do as well. Before we get into this episode, though, I want to quickly talk about our sponsors.

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Starting point is 00:03:20 Again, exodus.com slash Pomp for your free download or search Exodus on the App Store or the Play Store. All right, let's get in this episode with Caitlin. I hope you enjoy this one. Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments.

Starting point is 00:03:39 You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only. All right, guys, bang, bang. I've got Caitlin here with me

Starting point is 00:03:56 and we are going to talk about the Fed's new proposal. There's literally nobody better in the world than I thought to bring her on. So thank you so much for doing this. Hey, Pomp. It's great to be back on your show. Thanks so much. Absolutely. Let's just start off with what exactly did the Fed propose in this proposal? So they released, the Board of Governors released today a proposal for a 60-day comment period that is aimed at defining who can get access to the U.S. dollar payment system.

Starting point is 00:04:25 And that proposal has six principles in it. Five of them really have to do with risk. One has to do with, are you legally eligible? And the reason that the Federal Reserve put that out is largely due to what's going on in digital assets. Of course, they didn't say anything about digital assets, and there have been some other non-digital assets, fintechs, that have tried to get access to the payment system on a technicality with thin capital and without complying to the traditional rules that the Federal Reserve has historically put in place for access to the payment system. But the great thing about this is it's now transparent. It's now going to be obvious and an even playing field for everyone. And what most folks don't understand is that this is actually really positive for digital assets as a whole. There are certain rules that you have to abide by in order to gain access to the payment system. But the Federal Reserve has just put out the guidance for what those rules actually are. So for those that are like starting at 101, just when we talk about the Federal Reserve payment system, what exactly does that entail? And then we'll get into some of the rules that they're proposing here. So to get access to the payment system, historically, you have had to be a bank. A bank is defined under the relevant law as a depository institution. you have to be granted by statute the right to take U.S. dollar deposits. And so trust companies, so a lot of folks in the crypto world deal with firms that are licensed as money transmitters or trust companies. There are no banks in the crypto world that can handle crypto right now.

Starting point is 00:06:14 And so the money transmitters and trust companies are not depository institutions. They're not banks under that definition because they're not authorized to take U.S. dollar deposits. Now, if you take U.S. dollar deposits, you have to be able to clear those U.S. dollars somehow through the Federal Reserve. And there are really two ways to do that. One is you go directly to the Federal Reserve, which is Nirvana. And the other is you go through a third-party bank called a correspondent bank. And there are lots of banks that do both in the traditional banking world. In the digital asset world, there's been an elephant in the room, which is not the Federal Reserve.

Starting point is 00:06:51 It's actually been the FDIC. The FDIC has discouraged banks through their policy implementation. Nothing they've said publicly, but it's now on the record. There are actually folks talking about the FDIC has been the agency that has been the most reticent to have digital assets exposure within the banking system. It's worth saying the FDIC would never insure digital assets, just like they never insure securities. They only insure US dollar deposits, but they haven't even, even though they wouldn't insure digital assets, they haven't even wanted insured banks historically to touch digital assets. So those that do, and I've said this many times before, like Silvergate, like Signature, those banks have taken on a lot more regulatory burden

Starting point is 00:07:36 because they've got a regulator who doesn't really necessarily like digital assets. But until today's announcement from the Federal Reserve, it wasn't clear where the Federal Reserve stood. But to me, this is really bullish because now that we know that the FDIC has been the blocker here, what did the Federal Reserve announce today? It announced that uninsured depository institutions do indeed have access to the digital asset or to the payment system. So this has been put out for public comment, but of course, the Federal Reserve drafted the first proposal of it, so you can presume that they're in support of the proposal. So in other words, the FDIC not wanting to insure banks that handle crypto for custody or exchange purposes is no longer a blocker. The Federal Reserve has now opened the door to non-FDIC insured institutions to get access to the payment system. And so the real impact of all this, the aha moment is we can now actually have U.S. dollar clearing simultaneously with Bitcoin, Ether, other digital assets.

Starting point is 00:08:48 And there's been so much payment system. There's been so much settlement risk that crypto companies have had to take on as a result of the fact that crypto settles in minutes with irreversibility, whereas U.S. dollars settle sometimes in days. And you can reverse transactions for a long time. For ACH, it's really 90 days. And there are now rules that a consumer can dispute an ACH payment for up to two years. So you don't have the same settlement cycle timing-wise, and you don't have the same settlement finality. And that creates an enormous amount of risk for institutions that are handling crypto. So to be able to have an institution that can settle US dollars directly at the Fed and provide custody of crypto so you can cross those two transactions simultaneously, that's a big deal. It doesn't exist in this industry right now. And the announcement today from the Federal Reserve opened the door to that

Starting point is 00:09:49 officially. And so what it feels like is happening here is there's basically two various avenues that have prevented these crypto related banks, right? We'll call them banks, even though technically, in some cases are not considered banks, from accessing this payment system. One is the insurance issue, which you really described there in terms of FDIC not wanting to insure. The second is this idea of capitalization, right? And not meeting some of the capital requirements. Talk a little bit about what the requirements are and why some of the organizations that are essentially acting as banks, right? But why do they not meet those capital requirements? Well, if you look at what a trust company is, a trust company just holds assets in trust.

Starting point is 00:10:31 They don't guarantee the assets. They don't guarantee performance of the assets, of course. They're just holding it as like a money warehouse. And in some states, you can start a trust company for $500,000 in capital. And there was some potential for a loophole for a thinly capitalized trust company like that to be able to get access to the payment system. and the Federal Reserve essentially today said, no, you actually have to be capitalized like a bank. Even the OCC trust companies, of which there are now a couple in the digital asset industry,

Starting point is 00:11:03 Anchorage, Paxos, there are a couple of others now, either in the pipeline or that have already gotten their OCC trust company charters, they are not capitalized as banks. They are typically capitalized at about a quarter to a third what the bank capital requirement is, to give you some for the magnitude of the difference. And then there's so many rules for access to the payment system as being deep into it with Avanti. I've learned so much about the details behind a bank that can clear US dollars with the Fed. That is definitely a very high bar from a technology perspective, as well as from a payment system risk perspective and a compliance risk perspective. And the digital asset industry, until you become an actual bank and you start to go into those

Starting point is 00:11:52 rules and start plugging into the Federal Reserve, you don't see just how much work it is and how much testing on top of that, once you get integrated, has to be done in order for you to go live. But right now, the industry has been doing okay, but we have these relatively small banks that service the industry. And I've talked to a lot of the big players in the industry who are nervous about holding their deposits at these relatively small banks. Because remember, FDIC insurance only goes up to $250,000 if you put deposits at the banks that are serving the industry right now for US dollar services. So that's one thing. Most of the crypto players are putting millions, if not tens or hundreds of millions of deposits, and only $250,000 is

Starting point is 00:12:40 insured. And these banks are relatively small. So they want more banks. They want more access to different counterparties that have different and maybe better counterparty credit risk. As this industry is just exploding in size, I always like to point to Ryan Selkis at Masari saying, he's been warning about this for a couple of years now, that the relatively small number of banks that service the digital asset industry in the United States is a single point of failure risk for this industry. And it's potentially, if there ever were to be a regulatory crackdown, I don't think there will be, but also just the size of those banks. These are not large banks and this industry is just ballooning around them. And obviously they're starting to get some

Starting point is 00:13:32 industry concentration and that is starting to become a bit of an issue for some of the players in the industry. So they would like alternatives. And I think this announcement from the Federal Reserve today makes it clear there are going to be alternatives, but they are going to be specifically well-capitalized alternatives, i.e. not uninsured trust companies that are thinly capitalized. And they are going to meet all the requirements of managing the risk of being directly connected to the Federal Reserve. And the bar on that is very high. And I don't see any others other than those of us who are going through this exact process with the Federal Reserve, clearing that bar right now. And so if you are sitting with one of the companies that

Starting point is 00:14:15 are an OCC trust approved, that, you know, thinly capitalized, not insured, but did get the trust approval, does this simply mean that they're kind of carved out into the digital asset space so they can accept Bitcoin, Ether, whatever other cryptocurrencies, stablecoins, etc. And they just don't have access to that Federal Reserve payment system? Or is there some other structural challenge that they now face because of this proposal? No, it's the former. And in some cases, just having talked to some of the other players in the industry, they weren't looking for US dollar payment system access. So this is a nothing burger to them. For some that were looking at that back doorway to get payment system access with a quarter to a third of the capital and not having

Starting point is 00:14:59 to comply with all these other rules, they might be disappointed by what was announced today. But so the OCC trust companies, if all they were really doing was trying to figure out a way to not have to have 50 different state money transmitter regulators, they succeeded by getting the National Trust Charter. But the difference is, though, that that National Trust Charter does not give access to the payment system, so they will have to use a correspondent bank to clear their payments. And therefore, they're not able to offer a simultaneous settlement and an atomic swap of a US dollar versus a digital asset. Got it. And then when you think about Avanti, obviously, I'm an investor, and we literally

Starting point is 00:15:42 are talking about this live. So I'm going to get the investor update right now. What is the kind of impact on Avanti's business? It sounds like it's pretty much a tailwind here, and very, very bullish for the business. But how do you look at this and the impact on Avanti? Yes. Well, as you know, we've been waiting for this. We have been told that this was coming through our regulator. And so, of course, once you get it and you read it and you see that, boy, we think we comply with it all, it's a matter of the process working itself out. And as I mentioned, there are a lot of details. It's a surprising amount of detail in order to become a U.S. dollar clearing bank, in other words, to get access to the U.S. dollar payment system. And we are deep in the weeds of all those implementation details right now. So we don't have an announcement for an opening date. Obviously, this comment, this new proposal has to go through a 60-day comment period. That is, by the way, again, in Fed speak, for those who are watching, I've been told from Fed watchers, 60 days is fast. The Federal Reserve really wants to do something here. And I do have to say, I've been asked a couple of times recently about all the negative press surrounding innovation with the Fed and CBDCs and the U.S. falling behind. I can't say this often enough, and you've heard me say this on your show before, that the Federal Reserve could have shut down the digital asset industry's access to U.S. dollars by turning off those third-party banks at any point in time.

Starting point is 00:17:17 Every U.S. dollar ultimately has to clear through the Federal Reserve, whether it's through a bank that has a direct relationship or whether it's through a bank that has a bank that has a direct relationship. Every one of those U.S. dollars, right? So even with Tether, with the stable coins, but also with the companies that do business with Bitcoin or even you as a retail individual who might transfer money in and out of Bitcoin companies, every one of those U.S. dollars ultimately has to clear through the Fed. And so, frankly, the Fed has up until today been neutral on this. I've not been critical of their ability or of their willingness to green light innovation because they have by just not shutting this down. And they could have, but they didn't. And now they're building on the fact that they haven't shut it down with what they've done today.

Starting point is 00:18:11 I will say this, that the fact that they haven't shut it down doesn't mean they won't, right? I mean, it took Ripple eight years for the SEC to sue it over the unregistered securities offering. So these things can take a lot of time for enforcement actions. But I think it is important that there is now a clear path to digital asset companies to getting right with the Federal reserve and taking that asking for forgiveness instead of permission strategy off the table, which everybody in the industry, except for those who have actually gone and asked for permission, it's Kraken and Avanti so far, everybody else is in a position where they're having to ask for forgiveness because they did some things that were not in a black and white

Starting point is 00:19:02 regulatory area. And I think today's announcement does clarify how you can get into a black and white regulatory area with the Federal Reserve. And that is a big deal. As we move forward, it sounds like there's a 60-day comment period. What happens after that comment period's over? The Federal Reserve has to finalize the rules. And if you go and look at the history, sometimes it takes a long time to finalize. Sometimes the rules get finalized pretty quickly. Stay tuned. That's something only the Federal Reserve knows. Awesome. Last question for you, and then I'll let you go because I know you're busy today, is just as you look forward, does this lead to many more companies trying to pursue the SBDIs and other types of legal

Starting point is 00:19:46 structures? Does this separate and say, hey, if you want access to the Federal Reserve System, go that route. If you don't, then you'll still pursue that OCC trust license. What's the impact moving forward in terms of people who are trying to consider what the legal entity and the regulatory kind of structure that they should pursue is? Yeah. I think, frankly, today is such a validation. I've seen some of the Wyoming officials come out with statements as well. It's such a validation of what Wyoming did. We walked before we ran. We took three years to build the legal and regulatory foundation for the special purpose depository institution bank charter, which is the first new type of bank charter in the United States in apparently four decades. But we didn't just do it

Starting point is 00:20:29 on a whim. Some of the actions of some of the other states and of the OCC happened very, very quickly without, I would argue, some sound legal footing. For example, only in the state of Wyoming is commercial law clear, so you know you have clear legal title to your digital asset. And in fact, actually, I thought it was interesting in the Coinbase S1, the IPO prospectus, there was a warning regarding their lending business that it wasn't clear that they could legally foreclose upon the collateral pledged by a borrower in the event the borrower defaulted. And I suspect the SEC made them put that in there because I've known that that's an issue that the SEC has raised previously. That doesn't mean that the market's going to have

Starting point is 00:21:14 problems. It just means they don't have clarity, right? And so if you're going to start to get a bank license, you're going to need to have clarity in things like the commercial law. So I find it interesting that other states are trying to copy Wyoming's bank charter. Apparently, there are four others now that are trying to copy Wyoming's bank charter, but they haven't copied the other legal foundation and all that stuff. I mean, this has been a three-year process. The state of Wyoming has been in contact with the Federal Reserve for three years about this. And so the whole idea of some states or even the OCC coming in and kind of flipping a switch and suddenly changing the rules without a very methodical process, I think is interesting.

Starting point is 00:21:56 And so to your question, will Wyoming be the place that this industry ends up flocking to? Yes, I've said that for a while. I know we're not alone. There are two more um, SPDI charter applicants in the, in the hopper. And, um, and there are many others circling waiting for some clarity from the federal reserve. And once it comes, uh, yes, I think that, that, that flip has been, or switch has been flipped, so to speak. I love it. I'm long Caitlin long. I'm long Avanti. I'm a, uh, I'm a big fan, obviously. Uh, thank you so much for taking the time to, uh, to jump on real quick and help everyone unpack exactly what the hell is going on here. Uh, but overall, I think this is very,

Starting point is 00:22:42 very positive news for the entire industry. So thanks so much. And as always, we'll do it again in the future. Indeed. Thanks so much, Pop. We'll see you soon.

The Pomp Podcast - #548: Caitlin Long on the Federal Reserve Payment Proposal

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