Crypto firm Custodia Bank Inc.'s application to become a member of the Federal Reserve has been denied, setting up a roadblock in the company's bid to get coveted access to the central bank's payment system.

"The firm's novel business model and proposed focus on crypto-assets presented significant safety and soundness risks," the Federal Reserve Board said in a statement Friday. "The Board has previously made clear that such crypto activities are highly likely to be inconsistent with safe and sound banking practices."

The board also flagged Custodia's risk management framework, saying it wasn't sufficient to address concerns "regarding the heightened risks associated with its proposed crypto activities, including its ability to mitigate money laundering and terrorism financing risks."

Cheyenne, Wyoming-based Custodia Bank, which has been pushing for access, was recently told that it was unlikely to get approval, said two people familiar with the matter who asked not to be identified discussing the private conversations.

Fed Denial

"Custodia is surprised and disappointed by the Board's action today," said Caitlin Long, chief executive officer of Custodia.

"Custodia offered a safe, federally-regulated, solvent alternative to the reckless speculators and grifters of crypto that penetrated the U.S. banking system, with disastrous results for some banks," Long said in a statement.

She said the Fed's denial is "consistent with the concerns that Custodia has raised about the Federal Reserve's handling of its applications," and that it's an issue that the company will continue to litigate.

Long said the Fed advised Custodia 72 hours ago that it could either withdraw its membership application or see it denied.

Custodia, which previously used the name Avanti Bank & Trust, operates under a special state license for financial institutions that deal with digital assets including cryptocurrencies. The firm had sued the Federal Reserve Board and the Kansas City Fed over what it alleges is a "patently unlawful delay" in processing its application for a so-called master account.

Banking regulators have ramped up scrutiny of ties between the crypto industry and traditional lending following the spectacular failure of FTX, once one of the world's largest digital-asset exchanges, after it was revealed the firm had a relationship with a number of banks.

Earlier this month, the Fed, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. issued a joint warning about the need to stem risks associated with crypto assets so that they can't affect the broader financial system.

Democratic Sens. Elizabeth Warren and Tina Smith raised concerns in December about the crypto industry's ties to the banking sector and asked the Fed, OCC and FDIC to conduct a broad review.

Lydia Beyoud, Allyson Versprille and Katanga Johnson report for Bloomberg News.

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