Caitlin Long on Bitcoin's Banking and Investment Future

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1:31Welcome to Real Vision Crypto Daily Briefing. I'm Ash Bennington. We have a terrific guest for you today, Caitlin Long, founder and CEO of Custodia Bank. Caitlin, welcome. Hey, Ash. Great to be back with you all. It's great to have you back. Caitlin, we've got a lot to talk about here today. Very excited for this conversation. First, I want to take a look at some price action. And right now, Bitcoin on my screen,$27 ,090. It looks like on a trailing 24-hour basis, it's up about 2.5%, trailing seven days. It's up about 5%. We're going to talk about why in just a few moments. Ethereum right now trading at$1 ,733, trailing 24 hours.

2:08It's up about, call it three quarters of a percent, basically flat on a trailing seven-day basis. I also want to take a look at the Bitcoin dominance chart. This is an interesting one. You can see this chart here clearly rising. Let's talk, Caitlin, about everything that's happening in the space. I teased it at the top of the show, a lot going on. Obviously, from a regulatory perspective, a lot of large incumbents in the financial services space seem to want to get into the digital asset space right now. Caitlin, big picture, 50 ,000-foot view, where are we right now? What do you see going on?

2:40Well, we're in what appear to be the later stages of an all-of-government crackdown in the United States on the virtual asset service providers of various regulatory structures. And the news in the last couple of days certainly has raised some interesting questions about whether Washington, D.C. just wants to hand all this industry to incumbents. Well, let's talk about that. First, to touch on the first point that you made there, this apparent coordinated crackdown we see from federal regulators in the United States. Caitlin, you're a Harvard-trained lawyer. Talk a little bit about what's happening right now from a legal, regulatory, compliance perspective, because there's a tremendous amount of news flow there.

3:25Yeah. Well, first of all, I'm not a practicing lawyer. I can't give legal advice, but my company, Custody, is in the middle of it. It was arguably the first one that the federal banking agencies moved against. And at the time, we actually had an email from reporters who had been leaked in advance the news that the applicants for charters or master accounts at the Fed and the OCC had simultaneously been asked to withdraw their applications. These are supposedly independent agencies that are not supposed to be communicating with each other. Each application is supposed to be standing on their own.

4:10And the press, there is evidence, and we actually have evidence as well, that the White House was involved in this. So from the very beginning, this whole question, is there a coordinated crackdown? In retrospect, it's very clear. But we knew from the very beginning there was coordination, at least on the banking side. And then I started hearing that there was going to be actions on the security side. And it just basically every week there's been something new. And it's gone against all of the providers, really, in this industry. Pretty much everyone is untouched by this, which is why it's so interesting to see all these big incumbents come out today and announce the launch of their exchange.

4:54Yeah, you're referring to edX. We've got a Bitcoin spot ETF filing from BlackRock. There's a lot to talk about here. But let's walk through where Custodia is. I want people to understand a little bit of the context of this story. Back in January, I believe, the Fed rejected Custodia's application for a Fedmaster account. What exactly is a Fedmaster account? What's its relationship to the fundamental payment rails that banks use here in the United States? And why does it matter so much, Caitlin? Well, Fedmaster accounts are highly, highly coveted. And the reason is because that allows the account holder to bank directly at the Fed as opposed to having to face a commercial bank.

5:32And we saw with the commercial bank failures earlier this year that there's counterparty credit risk in facing a commercial bank, right? So, and there's costs, of course, as well. So, lots of entities want Fedmaster accounts. And there's been a lot of arbitrariness to who got them. And frankly, noncompliance with the law. The law says that all eligible applicants who are those, well, I won't even get into the details because it's a morass on the eligibility question. But it's clear custodia is eligible, and that's been acknowledged by the Fed. But the point is that the Fed is a utility, and the payment systems, namely Fedwire and ACH, are utilities to which the law says all eligible institutions have access.

6:23But the Fed has been picking and choosing. So on Friday afternoon, along this theme of incumbents getting special deals, the Fed released its database of master account holders. So basically, this is everybody who can bank directly at the Fed. And one of the most interesting things that jumped out is that a U.S. state has an account. Why don't the other 49 states have an account, right? I suspect you're going to see some treasurers of the other 49 states, you know, raising eyebrows and saying, hey, I don't want to have to face commercial banks. I'd rather bank directly at the Fed myself. but what's even more revealing is just the extent to which there's favoritism for incumbents in the application of who has a Fedmaster account.

7:11It's starting to drip out. I'm not going to name names for obvious reasons, but it's really stunning. So what's your interpretation of that list, the names that are on it, and perhaps more notably, the names that are not? Well, there are a number of names of questionable or likely ineligibility who are incumbents, right? Right. So, you know, last year there was a big brouhaha over a trust company called Reserve Trust that enlisted a former Fed governor, allegedly to help it get its application over the finish line, which was successful. And that that actually, you know, broke into a big story of revolving door favoritism at the Fed, denied by the nominee.

7:58But it actually ended up taking down her nomination for Fed chair. this new database, in my mind, releases a whole new thread on that reserve trust story. I don't think reserve trust was eligible for a master account. It got one, and then the Fed ended up revoking it for eligibility reasons. But what no one knew at the time was that there were large incumbents who had the same structure with the same issues who had Fed master accounts all along. And that was kept very quiet. And again, it's no wonder why the Fed dropped this database on a Friday afternoon before a three-day holiday weekend, hoping that no one would notice.

8:39Because, boy, there are some eyebrow-raising things. There's a professor, Julie Hill, who started tweeting about some of the eyebrow-raising ones this morning. And I think there will be a drip, drip, drip of a lot of eyebrow-raising things. But what does it get at in the broader sense? It's the same discussion that crypto Twitter is having this morning about incumbency favoritism. There is not a level playing field in the United States financial system, period. And who suffers from that? It's consumers. It's the small financial institutions, including small banks themselves. And it's any startup who's trying to break in.

9:21Yeah. Kaylin, I should point out, I know that you're limited in what you can say about this, but The suit that was filed by custodian against the Federal Reserve Bank of Kansas City has just been greenlighted by the 10th district to proceed. I believe this is the first suit to have been greenlighted by a federal district court to go forward. Can't talk about it, but stay tuned. It's definitely something that will evolve over time. Can you talk about what the goal of the suit is? Presumably it's to essentially reverse the ruling by the Fed to get the master account. If you were to get the master account at Custodia, how would that change what you were able to do in terms of your business model?

10:00Well, again, it gets at who has access to a central bank account. Because if it's only the large incumbents, boy, does that ever ensconce the large players. And it just helps explain why the biggest banks keep getting bigger and bigger and bigger. And those who are trying to bring new activities in a safe and sound way, completely complying with all of the rules and regulations of the existing system and can't break through. And so ultimately, that's what Custodio is trying to do. It's really offering a real-time gross settlement of Bitcoin versus U.S. dollars. Okay, because US dollars right now settle on old payment rails and they settle on a, in Fedwire, you can settle a payment within hours, but you can't program it so that it settles at 4.53 PM.

11:02Okay, ACH is for the most part next day or multiple day settlement. Hey, everyone, we're going to take a quick pause and hear a word from our partners. We'll be right back.

11:17Let me just give a little bit of context here for people who may not know. So there are essentially two different mechanisms within the banking system for transferring money, ACH and Fedwire. ACH settles net, Fedwire settles gross. The difference is Fedwire transactions are irrevocable. Once they are gone, they are gone. ACH transactions can be clawed back. The distinction here that you're making is this idea of programmability. Fedwire, very much a kind of 1970s, 1980s type technology, I think it's probably fair to say. But please go on. Well, and Bitcoin, of course, a Bitcoin block, it's appended to the Bitcoin blockchain every 10 minutes.

11:53So you start to see how you're not going to be able to settle U.S. dollars in Bitcoin simultaneously for the programmability point of view that you highlighted, but also just simply settlement time. So how do we bridge those two? That's what Custodial was set up to do, to try to actually take risk out of the system by ensuring that there isn't a settlement mismatch that could take a bank down. And if you go back and look at the speech that I made to the Cato Monetary Policy Conference back in 2020, I was warning that digital assets could take a bank down if the bank didn't hold enough cash to back these deposits that could be withdrawn in the span of minutes.

12:34And arguably, it wasn't precisely what I was talking about, because in that case, I was talking about stable coins. But I was pretty darn close in warning about what happened. And I was much more specific behind the scenes to regulators about the bank run risk at the banks that were serving the digital asset industry. And we're generally speaking, we're speeding up payment settlement across the board, not settlement yet, although FedNow is coming online. But online banking certainly speeds up the ability to request a payment. It used to be you had to go and stand in line at a bank branch and fill out a paper form.

13:09Now you can do it with a swipe of a phone. So bank runs clearly are speeding up. And the impact of that is it's revealing that the traditional banking system, it's always been fundamentally unstable, but it's even more unstable than folks have realized. And banks in general, as a result of the fact that the liabilities can be withdrawn a lot faster, are going to need to hold more cash. So the whole idea of custodia is to provide Bitcoin custody and to provide U.S. dollar services in a way that marries those two without one system causing problems for the other, like we saw. We saw the traditional banks cause problems for Bitcoin.

13:49We saw certainly the crypto industry cause problems for a few banks that failed. Yeah, that's spot on, Caitlin. And to your point, although the specific sequence that we saw in March and May was not exact, it certainly does rhyme. I mean, Signature Bank, Silicon Valley Bank, First Republic Bank. And you're right. It's absolutely all about this, right? If there are rumors of an insolvency in a bank and you have above the FDIC limit that's insured, why would you want to keep your funds there? And if you don't have to go and physically stand in line, I think we know those photographs from the 1930s about people standing around the block.

14:22There's no line. You just grab your phone, you do it, and it's done. suddenly capital flight is just almost instantaneous. If you look at what a very quick bank failure looked like in the 1980s versus what a very quick bank failure looks like, it's hours instead of days or weeks. Right. And that's what circles back to the fact that there were 414 uninsured financial institutions, the vast majority of which don't have a federal regulator that have these Fed master accounts because they're not facing a commercial bank. They're facing the Fed itself, which is the ultimate best counterparty. And so the fact that only the incumbents are getting those and the fact that a number of incumbents of questionable eligibility got them, but the startups are not able to.

15:07Wow. Is that ever evidence of the double standard? And if you go back and look at what the Fed said about custodia, it was the fact that custodia was uninsured. They spent a lot of time talking about that. Doesn't have a federal regulator. And of course, activities in digital assets. And in fact, actually, there were a couple of other things that we cut out of our business model and resubmitted to the Fed. The Fed still voted us down. But oh boy, there were a lot of banks that were approved, including one doing digital assets, and including a huge incumbent, Bank of New York Mellon, who's also doing the same things that custodia had sought approval from the Fed to do.

15:49But there's just this anti-startup bias and pro-incumbency bias that's very clear. And so you look at the double standards of uninsured banks and banks that don't have federal regulators. Look how many of them can bank directly at the Fed. And they're keeping the startups out. And the custodia is regulated or incorporated or structured as a Wyoming SPDI. This is a special purpose depository institution. I know that this gets complicated. There are a whole variety of different regulators here in the United States. But I want to home in on your point just to make sure that people don't lose it. Maybe I'll paraphrase it a bit.

16:26You tell me if I get this right. I mean, essentially what you're saying is if a crypto institution has to face another bank, they have that counterparty risk. And if the bank becomes insolvent for whatever reason, then essentially the customers of the crypto institution get marooned as those funds flee. You get the potential for insolvency and you have these challenges. is if you have a Fed master account, you essentially can bank directly with the Fed. You're eliminating that piece of the chain of counterparty risk where you have a bank sitting in between the crypto institution and the Fed banking system itself.

16:58But there's another angle. You're right about that. There's the flip side of it as well, which is that you don't want a leveraged bank. Every bank has the proverbial sort of Damocles hanging over the head, right? that if there's a rumor of a bank run, now we know within hours the bank could go down, right? That's not new. That's always been there. What's new is that it's just sped up because of phones. Okay, but here's the punchline. The banks are inherently leveraged. They're all essentially existing on the presumption that not everyone will go get their deposits at the same time, So this is why they borrow short-term, in other words, from the demand depositors who all have the ability to get their money back immediately on demand.

17:44But they'll take some portion of that money and lend it out long-term. This is the old borrow short-term and lend long-term maturity transformation business model. It doesn't work anymore in an internet speed settlement system. That's the fundamental tension. Okay, so what you described is absolutely spot on, Ash, but there's also a flip side of it, which is that I don't want the Fed to face these banks that might go bust either, right? You don't want the banks to default on the Fed. So the way you handle that is you have these specialized payment banks or gateway banks that handle these payments but cannot lend and have to hold 100 % of their cash on deposit at the Fed.

18:29That's the solution. And a lot of people are talking about that in the face of what's happened with the banks that failed. Every bank's going to have to hold a lot more cash. But what's that going to do to lending? The Fed doesn't want anyone defaulting on it. So why don't we just carve out the gateway banks, if you will, the payment specialist banks? The UK has them. There are other countries in the world that have them. They are not permitted to lend, but they do have accounts at the central bank. And so you don't have this risk of these tech forward activities causing bank failures and defaults on the central bank.

19:08You should separate out the two. And in fact, actually, the Fed's going in the opposite direction. And I would argue the Fed seems to be going and the FDI seems to be going in the direction of pushing us back to an analog world. The great irony is that the more analog they want the systems in the banks to be, because they're going to put a limit, for example, on FedNow of$100 ,000. Well, you know, most businesses, their payroll is more than$100 ,000, right? So it's not useful, certainly, for high value payments. But here's the point. They would much rather slow everything down because that slows down the risk of bank runs.

19:47What's that going to do as they continue to push the banks away from faster payments? It's going to cause people to just walk with their feet into the crypto market. because it's just like when the taxi and limousine commissions tried to stop Uber. People understood the user experience was so much better with Uber and Lyft than it was with you, you know, waiting in line for your taxi. And, you know, the taxi was, it didn't give you any digital experience. You had an analog receipt if you had to put it in for expense reimbursement. If you left something in the cab, good luck trying to find it later because you couldn't figure out exactly which cab you were in.

20:24Those kinds of things, right? Uber solved all those problems. And the Taxi and Limousine Commission tried to keep Uber out, but how did it ultimately succeed? People just voted with their feet. So the more that the regulators try to keep crypto out and try to push the traditional system back to slower transactions, the more people will just vote with their feet to crypto, particularly Gen Z and millennials. Hey, everyone, we're going to take another quick break and hear a word from our partners. We'll be right back to the Real Vision Crypto Daily Briefing.

21:01Yeah, I want to double click on this because this is such a series of important points that you've made here. Two points. To the Scylla and Charybdis that the Fed faces right now, on the one hand, as you say, they don't want these insolvencies. Clearly, they are terrible for the broader economy. But also, they don't want, on the flip side of that, they don't want the contraction in lending that would result from the slowing, the deceleration of credit supply to the economy. This is a significant, significant challenge. But Caitlin, to your point, I mean, this is a really fundamental critique that you have just leveled right now against fractional reserve banking, against the current structure of liquidity transformation, as it's called in the business.

21:38This idea that basically the banking system that we have is no longer fit or suited for the 21st century. That is a profound critique of where we are today. Correct. And Mike Shedlock wrote a very interesting blog post yesterday where he said, look, we really need to bring in the long-term savings, like the pension funds or the life insurance companies, right? They tend to invest very long-term. That's who should be making long-term loans. You shouldn't have the banks engaging in maturity transformation, playing this this three-card Monty game of, well, I'll tell everybody that they can have their deposits back on demand, but I only keep seven cents of the deposits in cash.

22:22So if more than 7 % of the demand deposits get withdrawn in a short period of time, I'm in trouble. And that's exactly what happened to all the banks that failed. And by the way, we've seen a big migration of deposits to these very large incumbents, again, like back to this whole theme, watch what they do, not what they say. They say they don't want to make the big incumbents bigger, but Lordy, look at what's actually happening. They've created an incentive for people to put their deposits in the large incumbents, but guess what? And by the way, a couple of them have questionable Fedmaster accounts, but here's the thing.

22:56The deposits, the cash at the large banks is only about 10 cents, right? So the delta, if you will, between the smaller banks is$0.07 versus$0.10 at the larger banks. You're not getting that much more safety because the larger banks aren't sitting on that much more cash than the smaller banks are. It's fundamentally an issue of fractional reserve banking, to your point. And I think this is just going to continue to dodge, to haunt the regulators in the coming years. They're going to be playing whack-a-mole against this because everybody has an expectation of internet speed, user experience. And as they try to push everybody back to a bank branch, talk to a 20-year-old.

23:44A 20-year-old has never been in a bank branch and never written a check. And has no desire to. Correct. And they'll never go backwards like that. There's definitely a generational thing, as you and I've talked about before on your show in the crypto space. There are a lot few boomers using crypto than there are Gen Zers, for example. And it is actually pretty much a straight line based on generation as to who's actually using crypto or not. But yeah, it's a really interesting conundrum that the regulators are in. But I think if you look at what they're actually doing, while they say they don't want to make the big financial institutions bigger, Oh, boy, that's what they've actually done and are seemingly encouraging, especially as they keep startups who really want to comply completely out.

24:39Yeah, well, I was going to ask the rhetorical question, who wants to bet against progress, future and digitization? And the answer is not, not Chuck Schwab, Fidelity and Citadel. Let me just read this headline because this is really important to understand the news flow today, exactly as we have this conversation. This is from the Wall Street Journal. Crypto exchange backed by Citadel Securities, Fidelity, Schwab starts operation. EDX markets won't directly handle customer funds, digital assets, or directly serve individual investors. Here's the lead. New cryptocurrency exchange backed by Citadel, Fidelity, and Charles Schwab is seeking business from brokers and investors interested in digital assets, but wary of troubles at FTX and Binance.

25:19The venture EDX markets quietly began executing trades in recent weeks. This is already happening, folks, if you're curious about that. EDX released a statement about the launch Tuesday, nine months after its backers unveiled plans for a crypto marketplace. You know, this is really interesting because very clearly, as you've said, we see this, what appears to be at very least a coordinated effort by some federal regulators to slow down or inhibit some of the existing players, particularly Coinbase, who many in the space believe to have gone through a great deal of trouble to be a good actor, to attempt to follow the rules of the road, so to speak, that have been laid out.

26:00and seeing this, it's really an interesting moment. And by the way, we should also talk about the BlackRock Spot Bitcoin ETF that's been a pluffer. Let's talk about, what are your thoughts on that? Well, it's the same thing, right? And so the world should be looking to see if there is favoritism towards the true large incumbent insiders. The SEC has been blocking ETFs for years from the smaller startups. And admittedly, there were some larger ones that also applied that they blocked. But BlackRock is the 10-ton gorilla in the asset management industry. And if they squeak through while all of the others didn't, the outcry, again, is going to be huge.