In August 2022, Custodia, a digital asset firm, applied for a banking license. 

CEO Caitlin Long had in mind a unique and simple business model: Custodia would take money from depositors and deposit it at the Fed, where it would collect interest.

Customers would then receive that interest, minus a small fee.

Simple. Safe. Smart.

In other words, Custodia wanted to become a full-reserve bank.

On its face, it was a win-win-win.

Depositors would get a small return without taking risk, the bank would profit, and the Fed would sleep soundly at night knowing something like Custodia exists.

And yet…

In January, the Fed denied the application, citing that it was ‘inconsistent with legal requirements.’

Caitlin Long called the denial a part of the Biden administration’s campaign against crypto: “shooting the stallion to scatter the herd.”

And mayhaps so.

But Custodia wasn’t the only bank of its kind denied.

A Menace to Instability

The Fed also denied another bank, Narrow Bank, back in 2018. And the Narrow Bank had nothing.. zip, zilch, nada… to do with crypto.

The reason it was rejected?

One compelling notion: Full-reserve banks are too stable.

As Custodia said in a press release, just after Silicon Valley Bank, Signature, and Silvergate bit the dust:

“The demise of these three banks underscore the danger facing any fractional reserve bank when all its demand depositors come back to claim their money at the same time and the bank does not have adequate cash.”

And that:

“The US urgently needs to put in place safe business models for the banks that bank the fast-moving industries, like that proposed by Custodia, so that the Federal Reserve does not need to backstop such banks. Custodia proposed to hold $1.08 in cash for every dollar deposited by its customers.”

Let’s say you had a company, let's say Roku, and you had an immense sum -- say 400 million in cash. After an anxiety-ridden three days, fearing you'd lost it all, wouldn't you consider a bank like Custodia over a bank like Silicon Valley Bank?

That’s why the Fed said no.

If full-reserve banks are banks made of bricks, banks like Silvergate, Silicon Valley Bank, and Signature Bank are made of wheat stalks.

The last thing TPTB want is brick banks calling into question their empire of straw.

Too Safe to Exist (TSTE)?

In 2023, rapidly increasing interest rates led to $600 billion in unrealized losses in the banking system.

And even The Economist admitted the Fed’s role. 

Also, it’s worth noting that the FDIC insures about 1% of total bank deposits in the US.

Who else remembers this gem from March 2020, when the market was melting down and the FDIC was spooked?

If full-reserve banks were easily available to investors, how would that change banking? Especially in times of uncertainty? Especially when other, fractional reserve banks are failing? Would we even need the FDIC?

The truth is that a full-reserve bank cannot exist, because of how appealing it would look during times of crises.

It’s TSTE -- too safe to exist.

“The Fed did not stop the Narrow Bank from operating because it was dangerous,” said author Saifedean Ammous in his book The Fiat Standard, “but because it would expose just how dangerous the rest of the banking system is and how much demand exists for safe savings.”

In a world of unstable money, stable money is a mischief.

BUT, here’s an interesting question for the future…

Stablecoins: the Answer?

Stablecoins -- cryptos pegged to assets like the dollar -- may offer an elegant solution to the “risks” of full-reserve banking.

With Paypal jumping in the stablecoin arena -- announcing its launch of PYUSD this week -- things are about to get A LOT more interesting on the stablecoin-regulatory front. 

Tomorrow, we look at the good, the bad, and the fugly of PYUSD.

And why…

Although stablecoins can be a good idea…

You should (probably) sit this one out.