Custodia Bank has partnered with Texas community bank Vantage to mint, transfer and redeem a deposit token on the Ethereum blockchain. The reason for using quotes around the term “stablecoin” is because deposit tokens on a permissionless blockchain appear similar to stablecoins, but if they are purely backed by deposits and issued by a bank, then legally they are different. They’re simply a bank deposit using a different technology.
With stablecoin laws progressing through Congress, both the House and Senate versions of the legislation exclude bank-issued tokens backed by deposits, precisely for this reason.
The solution isn’t yet live, so it was a series of test transactions using Avit tokens (Custodia’s brand) on behalf of a bank customer. Custodia noted the benefits of low transaction costs, speed and programmability. Both sets of bank regulators monitored the transactions which featured the compliance requirements you’d expect for banks.
After minting the tokens, they were transferred to the customer wallet and used for B2B transactions outside of the banking system before being redeemed at Custodia Bank for demand deposits.
“We broke ground on the legal/regulatory front, proving that U.S. banks can collaborate to tokenize demand deposits on a permissionless blockchain in a regulatorily-compliant manner,” said Caitlin Long, CEO of Custodia Bank. “Custodia looks forward to the reversal of U.S. regulatory obstacles that have stymied stablecoin innovation in recent years, so that American consumers can benefit from the substantial network effects and global reach of permissionless blockchain technologies.”
While the Avit tokens used Custodia’s technology, the bank deposits were at Vantage, and it used Vantage for Fedwire/ACH services.
Custodia’s uphill path
We’d observe there would be some benefit to Custodia providing the deposit services. Why? Because it has a special charter which requires it to keep one-to-one backing for deposits, rather than fractional reserve banking. There’s nothing wrong with Vantage’s deposits. Like most healthy banks, they function perfectly well 99.999% of the time.
But full reserve deposits would be perfect for that 0.001% of the time. And would be attractive to most regulated stablecoin issuers, especially after Circle’s USDC stablecoin de-pegged following the collapse of Silicon Valley Bank.
Arguably, stablecoin issuers might pay for that service or certainly agree to receive reduced interest. But only if the custody bank has direct access to the payment system to support speedy redemptions.
Custodia has been battling with the Federal Reserve in order to get direct access to a Master account and payment systems, rather than needing to go indirectly via other banks such as Vantage.
One of the Fed’s objections was that without fractional reserve banking, the business model was unclear. While interest rates are at the current level, Custodia could probably make at least 3% on many billions of deposits from stablecoin issuers. For example, Circle’s USDC has around $7 billion in deposits, although Tether only keeps nominal amounts of cash.
Silvergate and Signature banks are unfortunate examples of banks overly exposed to the crypto sector. However, we’d note that following the crypto crash Silvergate conducted a relatively orderly wind down and Signature was a fractional reserve bank, where the reasons for its demise were disputed.
Meanwhile, there are several examples of tokenized deposits in the United States using permissioned blockchains, including Silvergate and Signature. Signature used Tassat’s solution, as does Customers Bank. However, both only work between customers of the same bank. The same goes for Citi Token Services and JP Morgan’s Kinexys Digital Payments (formerly JPM Coin).
Ledger Insights Research has published a report on bank-issued stablecoins and tokenized deposits featuring more than 70 projects. Find out more here.
