While the U.S. federal government has yet to create a clear legal framework for cryptocurrencies, Wyoming has proposed its own crypto regulations, the most prominent of which is the Wyoming special purpose depository institution (“SPDI”).
The Wyoming SPDI has received extensive fanfare in the crypto community because of its potential to move the ball forward on crypto banking and financial innovation, but faces an uncertain future in the face of apparent opposition from federal regulators.
However, there may be hope for these innovative crypto banks. Recently, Federal Reserve Chairman Jerome Powell entered the fray by stating that the Fed would “make some progress” in opening the door for SPDIs to achieve wider, federal recognition.
In this article, we explain the Wyoming SPDI, why it is important for the future of crypto innovation in the U.S., the challenges that the SPDI faces moving forward, and why there is good reason to be optimistic about SPDIs eventually gaining the wider federal recognition that they deserve.
What is a SPDI?
SPDIs allow crypto companies to create financial institutions that can receive deposits and conduct other activities incidental to the business of banking, including fiduciary asset management, asset servicing, fiduciary asset management, custody, and related activities. SPDIs are important to the intersection of crypto and finance because crypto firms have historically faced difficulties in using traditional banks for services as simple as payroll. Thus, the SPDI is meant to supply an alternative for those looking for crypto banking services and fill a vital market need in the crypto ecosystem.
Most states require new banks to obtain Federal Deposit Insurance Corporation (“FDIC”) insurance, that covers some U.S. dollar accounts, but does not protect other assets such as cryptocurrencies or stocks. However, the Wyoming SPDI allows crypto companies to offer banking services without FDIC insurance, instead using additional burdensome requirements to protect accountholders. As a result, Wyoming SPDIs must abide by several requirements that other banks do not, such as:
1) SPDIs cannot offer loans;
2) they must hold enough assets to cover 100 percent of deposits while maintaining another 2 percent of deposits as a contingency account “for unexpected losses and expenses”; and
3) before opening, shareholders funding the SPDI must have at least $5 million along with a surplus funding covering “three years of estimated operating expenses.”
These requirements are intended to assure regulators and customers that SPDIs will stay solvent despite the high volatility of crypto assets.
As a result of these rigorous requirements, the application process for a Wyoming SPDI is lengthy and comparable in time and effort to securing approval for a conventional bank.
Current Challenges to the SPDI
Despite these stringent regulatory requirements to ensure consumers are protected, SPDIs are still unrecognized by the Federal Reserve. Federal recognition is highly desirable for Wyoming SPDIs because it would grant them access to the Federal Reserve via a master account, which makes it much faster and cheaper to process customers’ orders, take FDIC-insured deposits, and be exempt from individual state licensing. While Wyoming has indicated that it is developing partnerships with other states to ensure multi-state recognition, these efforts have not yet materialized.
Two Wyoming SPDIs, Kraken and Avanti received their bank charters in 2020 and applied for master accounts with the Federal Reserve Bank of Kansas City soon thereafter. However, more than a year later, the Fed has not processed these applications, which implies that it is still determining whether SPDIs are banks.
Wyoming Senator Cynthia Lummis (R-WY) has argued that, in not acting on these applications, the Fed has violated the law for three reasons. First, in 1994, Congress passed legislation requiring the Federal Reserve to act on all applications within a year. Second, many federal courts have ruled that the Fed must give payment system access to all banks and credit unions conducting legal activities. Finally, the Fed has stated that its payment services are available “to all depository institutions on an equitable basis . . . in an atmosphere of competitive fairness.” However, it is currently unclear whether Wyoming will be able to act upon these arguments effectively in its bid to achieve wider federal recognition for its SPDIs.
In addition to opposition from federal agencies, the Wyoming SPDI also faces hostility from banking organizations such as the American Banking Association (“ABA”). These organizations have opposed SPDIs principally because they argue that SPDIs have lighter oversight and fewer investor protections than federal banks. Without support from the ABA, SDPIs cannot access an ABA routing number, which is an essential tool for U.S. financial institutions to conduct transactions.
Can the Wyoming SPDI achieve wider recognition?
In the wake of these daunting challenges, new comments from Federal Reserve Chairman Jerome Powell may blaze a trail for SPDIs to truly come into their own as an integral part of the U.S. banking system.
In the hearing for his reconfirmation as Federal Reserve Chairman, Jerome Powell recently defended the Fed’s policy of delaying its decision on whether to give master account status to SPDIs, citing their “novel” nature.
However, Chairman Powell’s statements do not mean that Wyoming SPDIs will never be approved. In fact, Powell argued that there are “good arguments” for treating them as eligible to receive master account status. Powell also stated that he recognized that approving a SPDI to receive master account status would be “hugely precedential” and, thus is why he is “taking [his] time on this.” Hopefully, this means that Chairman Powell will recognize the incredible importance of SPDIs and support states in pursuing crypto innovation. The strong safeguards that the Wyoming legislature put in place help to guarantee that regulators’ worst fears are unlikely to come to pass.
While there is a long road ahead, there is good reason to be optimistic about the future about the Wyoming SPDI and other local experiments in crypto regulation.