As top federal officials like Janet Yellen, Jerome Powell and Gary Gensler debate how cryptocurrency and the companies involved in it should be regulated, and members of Congress consider 18 bills tied to digital assets, states are quietly enacting their own laws and issuing charters for crypto companies.
Wyoming and Nebraska have created special-purpose bank charters and a set of rules for startups and existing banks that want to provide services related to digital currencies. Illinois has proposed legislation to do the same, but it has not been approved. The work these states have done and the rules they have developed could serve as blueprints for any national framework and what crypto banks will look like in the future. Their efforts also have shown that bankers’ initial objections to crypto banks tend to wear off when banks are given the same rights crypto companies are granted.
In a way, New York was the pioneer in this area. It does not offer a crypto bank charter per se, but it does provide the so-called BitLicense, a business license for virtual currency activities, and limited-purpose trust charters. The New York State Department of Financial Services did not respond to a request for an interview, but its website lists 26 virtual currency companies to which it has granted a license, including Circle Internet Financial, Coinbase, Gemini Trust and NYDIG.
In 2019, Wyoming created a special-purpose depository institution charter. Companies that receive this charter become banks that can receive deposits and provide custody, asset servicing, fiduciary asset management and related activities. They are prohibited from lending and must invest 100% of customer deposits in cash, Treasury bills and other high-quality liquid assets.
Though some have questioned Wyoming’s approach, those behind the charter say it was carefully thought out.
“Wyoming’s SPDIs are subject to a straightjacket: They cannot rehypothecate customer assets, even if a customer wants them to,” said Caitlin Long, founder and CEO of Avanti Bank in Cheyenne and a two-decade veteran of Wall Street. “Wyoming’s charter is hyperfocused on solvency and is the polar opposite of Wall Street’s highly leveraged, highly rehypothecated regime.”
Both are waiting for the Federal Reserve to approve their applications for a master account, which is necessary for a financial institution to have direct access to the central bank’s payment systems.
“Our road map is as fluid as it has to be given regulatory timelines, but the bank doesn’t have any customers currently,” said Marco Santori, chief legal officer of Kraken Digital Asset Exchange. “We hope that it will soon, but we really do have to accommodate the timelines of folks like the Fed.”
Nebraska was next. In May, a bill sponsored by Republican state Sen. Mike Flood, the Nebraska Financial Innovation Act, became law. It created a state banking charter that lets new companies become digital asset depositories and authorizes state-chartered banks to operate digital asset divisions.
“For the last 10 years, places like Austin, Boston and San Jose have been leading in job growth and creation,” Flood said. “As a state senator serving a rural part of northeast Nebraska, I’m looking for ways to create high-skill, high-wage jobs in the middle of America, with the best workforce available in the nation that comes off of dairy farms and farming operations, where the work ethic is unparalleled.”
While he was running for office, a college classmate told Flood he was moving his business to Wyoming. When Flood asked why Wyoming, the friend said because the state had passed the nation’s first cryptocurrency bank charter act and that he planned to apply for a bank charter.
“I thought, there’s absolutely no reason that this cannot be done in Nebraska,” Flood said.
The Nebraska law gives the digital asset repositories and banks with digital asset departments the right to issue stablecoins. In this aspect, it mirrors a letter the Office of the Comptroller of the Currency issued in July 2020 allowing national banks to issue digital assets.
The Nebraska law requires every stablecoin to be backed by a dollar in a federally insured account.
“I know some states are going to look at that and think that it completely violates the freedom that cryptocurrency represents and the reason that some people really gravitate towards these digital assets,” Flood said. “I think it’s just the opposite. If I were a regulator, I would want to know that we weren’t giving up this security that comes with the word ‘bank.’ We don’t want to wound the implicit trust people have in our banking system or our regulators.”
The law lets existing state banks form a digital asset depository department similar to a trust department, still regulated by the state department of banking.
“It adds value to Nebraska charters and hopefully creates opportunities and jobs all over the state of Nebraska,” Flood said.
Flood says he had the “benefit” of a grueling three-month legislative process, including hearings and negotiations with many bankers who initially opposed the bill.
To the bankers, the bill introduced unknowns. “They understand their business,” Flood said. “They understand fiat currency. When you all of a sudden introduce digital currency or digital assets, there’s a disconnect.”
The bankers also objected to the use of the word “bank” in the new charter.
“In Nebraska, using the word ‘bank’ conveys so much more than anybody ever thinks about to a consumer,” Flood said.
One of the compromises Flood reached with the banker critics was that the new companies’ stablecoins be backed by reserves in accounts insured by the Federal Deposit Insurance Corp.
The Nebraska act emphasizes compliance with all existing national and state banking laws, Flood said. It also requires many disclosures, including warnings that the value of cryptocurrencies could fluctuate.
Flood compares cryptocurrency today to the internet in the 1990s.
“The internet in 1995 was full of cowboys, porn and fraudsters,” he said. “Legitimate players in America and the world were running towards regulation, running towards safety and soundness. I want Nebraska to attract people that want to be regulated.”
Nebraska’s banking department is currently setting up rules for the new digital asset repositories and is not receiving applications yet.
Though he is a big believer in states’ rights, Flood said he isn’t worried about crypto rules coming out of Washington.
“If the Federal Reserve were to come out and say, we need two or three more things, I wouldn’t have any problem modifying the bill to meet those standards,” he said. “At the end of the day, I think we make a mistake as a state if we try to push something past the goalie.”
In Illinois, state Rep. Margaret Croke, a Democrat, has proposed a bill that would create a special purpose trust company for crypto startups and banks. It has passed in the state’s House of Representatives and awaits a Senate vote that is expected to take place this week or next.
Croke was already interested in cryptocurrency when Chasse Rehwinkel, acting director of banking for the Illinois Department of Financial and Professional Regulation, released a report on blockchain and crypto that suggested Illinois should do something similar to Wyoming, to allow businesses that deal in crypto to use banking services.
“If you’re engaging in a legal business, as many crypto companies are, you should have access to banking,” Croke said.
Unlike Nebraska’s law, to which bankers objected, the Illinois statute met with no industry opposition.
“Banks like it because community banks can get involved in this, and these special-purpose companies have to get a banking charter the way banks currently do,” Croke said.
If and when the Illinois Senate passes the bill, traditional banks will be able to do all the things the newly chartered trust companies can do, without special permission. They will need to notify state banking regulators of their plans.
“Illinois bankers are proponents of this regulation,” Croke said. “They’re not just neutral, they’re excited about it.” At a recent event where she spoke, about 65 community bankers all wanted to talk about the potential for being custodians of digital assets, she said.
The newly chartered companies will not be allowed to use the word “bank” in their names.
“The use of the word ‘bank’ was worrisome; that was something community banks brought up,” Croke said. “We were adamant that they not use the word ‘bank.’ ”
Croke acknowledged that even when her bill becomes Illinois law, the federal government could supersede it.
“Our goal was to set up infrastructure and hope it would be modeled by the Fed and other states,” she said. “Because the state has some agency around the way we charter state banks, we should be able to continue to do things at the state level and charter de novo companies if we want to.”
Still, Croke said, she would actually prefer to see a larger-scale regulatory structure from the Fed.
“That would take pressure off the states,” she said. But she also worries that as companies are going through the process of obtaining the Illinois charter, the federal government might require them to jump through additional hoops.
The U.S. has long had a dual banking system, and at times state and federal bank regulators have been at odds. For instance, in 2018 the New York banking department sued the OCC over its proposed special- purpose bank charter for fintechs, claiming the charter would represent a significant federal overreach. The Conference of State Bank Supervisors has filed a lawsuit seeking to block the OCC from granting a national bank charter to Figure Technologies. These suits are working their way through the courts.
“I think that the dual banking system is the foundation of the successes that we’ve seen in banking in the U.S. broadly,” Santori said. “I don’t think anybody wants a world where there’s just one single monolithic bank regulator that can determine the landscape of banking by dictate. We chose Wyoming and the Wyoming charter for specific reasons, and the availability of a charter like that is the product of the dual banking system.”
A national bank charter would not have been a good fit for Kraken Bank because it has no intention of building a lending business, he said.
“Wyoming has been a trailblazer, and the state has addressed and foreseen a number of challenges to companies,” Santori said. “But you also have to believe that taking an iterative approach to charter creation is going to yield better and better results. They aren’t going to leave Wyoming in the dust by any stretch. I think we can all learn from each other. And that’s part of the benefit of a dual banking system is that you can have the states acting as laboratories for new ideas.”
State officials often say they know what’s best for the people and companies in their territory than the national government does.
“In my opinion, innovation starts in the states,” Flood said. “It should never start at the federal government. In the states it’s our job to push and to explore and to create using our sovereignty. The people in Nebraska have a one-50th opportunity to decide how things go within our nation, within our boundaries, and using that state sovereignty, we have every right in the world to set up a digital asset charter.”