Wyoming’s Crypto Banks and the Wild Wild West of Web3 Regulation

July 29, 2022 - 16 min read

The Cowboy State has led the way in the US in terms of enacting legal protections for businesses dealing with digital assets and all things related.

wyoming crypto legislation bitcoin sunrise


One of the benefits of decentralization is that it allows for what Austrian economist Joseph A Schumpeter coined as ‘creative destruction’ back in 1934. Creative destruction is essentially the natural cycle of experimentation and adaptation which takes place within economies as innovation or stagnation occurs. That is, productive investments flourish, are replicated, and eventually are refined further; while unproductive investments eventually flounder and fail, aren’t replicated, and so this is how an economy progresses. Decentralization leads to a multitude of economic experiments to be run simultaneously, allowing for rapid evolution and innovation.

The US was originally designed to give power to the states, while restraining the amalgamation of power at the federal level. This core principle of the union’s architecture, combined with the optionality resulting from peoples’ freedom to move throughout the US, allows for state laws to be as bold and dynamic, or conservative and static, as their populace desires. Thus, there is a constant tug-of-war happening between the jurisdictions of individual state governments and that of the federal government, and crypto just happens to be one of those areas where the action is happening. 

The Web3 crowd has found allies within the leadership of Wyoming’s government, and is having healthy conversations about crypto adoption and the protection of digital assets under the law. However, the road to crypto adoption is treacherous and uncertain, and small victories should be celebrated and emulated where they may be effective. Strategies for success are still controversial and up for debate: is Web3 at war with fiat and the US dollar, or is it an ally to live alongside ‘king dollar,’ but simply poised to offer more efficient infrastructure for which it is to move its operations?

According to ancient Greek legend, the use of what we now know as a Trojan horse gave Odysseus and his war-weary Greek hoplites the opportunity to secretly enter the city of Troy against all odds, and win the Trojan war. The Trojans were lulled into thinking they were safe in their positions of power before falling asleep, at which point the Greeks emerged from within the wooden horse, sacking the city and claiming victory. 

Perhaps the crypto crowd can learn a thing or two from history in bringing about their own goals in the face of opposition from traditional banking and finance, or those insinuating that digital assets might threaten the US dollar’s world reserve status. Let us examine some trends originating from the state of Wyoming in the Mountain West sub-region of the US and see if any knowledge might be gleaned from recent happenings.

The State of Wyoming: Leading the Way in US Crypto Legislation

Although perhaps not widely known, the state of Wyoming is widely regarded as a trendsetter when it comes to digital assets and regulatory sandboxes protecting fintech startups there. Those in favor of crypto adoption laud it as an example to admire, while critics indicate that crypto firms are tricking lawmakers into helping them avoid oversight and regulations required of traditional banks, not to mention serving to undermine the US dollar. Nevertheless, new updates to Wyoming’s DAO regulations will further add to the attractiveness of doing blockchain transactions and other crypto firms doing business in the Cowboy State. 

Wyoming has added dozens of DAOs incorporated in the state since their Legislature passed a law in 2021 specifically with language encouraging their development and proliferation, and taken a hands-off approach in their treatment of digital assets more specifically. As a quick example, Wyoming passed Bill 111, exempting cryptocurrencies from property taxation in the state.

DAOs- top down vs decentralized autonomous organizations
DAOs offer a novel governance structure, which could create headaches as they attempt to co-exist in a system designed around trusted reputations, FDIC insurance, and other official infrastructure managing accountability.

A new state law, SF 68, essentially updates the state’s existing DAO statute with more precise language regarding how people join and participate in DAOs, according to proponents of the changes. DAOs use blockchains and smart contracts as their organizational and enforcement mechanisms, as they leverage decentralized means of enforcing honesty and transparency

This is of course becoming increasingly attractive as people demand such transparency from law enforcement, medical establishments, political bodies, and other forms of collective cooperation which could benefit from decentralized, trustless governance or oversight. However, before getting into the details about what is on the horizon for the Cowboy State when it comes to crypto and everything Web3, it is important to note that it was not an accident to become a welcoming place for entrepreneurs and crypto enthusiasts more specifically. There has been a concerted effort to advance crypto towards legal recognition leading all the way up to the US Federal Reserve Bank.

After Crypto-Friendly Wyoming, Nebraska and Arizona Follow Suit

In recent years, Wyoming has enacted a number of new laws designed to enable cryptocurrency businesses in the state. Wyoming is one of the few states which has created a legal framework that not only permits, but seems designed to invite key players in the crypto industry to set up their fintech operations in the state to benefit from the incentives placed before them. 

Wyoming’s new laws legally recognize the property rights of digital asset owners as well as authorize and protect transfers of the digital assets for both individuals and corporations. HB 101, for example, authorized corporations to use electronic networks and databases for recordkeeping and asset transfers, specifically using language such as “private keys;” a move many viewed as being specifically welcoming to users of blockchain technology and digital assets more specifically. The logic applied here is that a company’s assets will be deployed when their operations can be more clearly planned out in terms of economic feasibility, but also without the fog of regulatory uncertainty.

custodial vs non-custodial wallets for web3 crypto
Custodians are easily understood as the ‘keepers of the keys.’ When users create accounts with digital asset custodians or use custodial wallets, they simply create an account password without taking possession of the private keys. The concept is not entirely different from the way fiat banking is done today in that users trust banks to keep their deposits safe and accounts secure.

Therefore, if the state’s commercial laws and protections apply to crypto just as they would to fiat money or other legally recognized forms of property, companies can let innovation and market forces drive their decision making without fears they’ll be punished later on for operating in legal “gray areas.” It has also led to job creation and higher efficiency regarding services offered to citizens of the state.

For instance, a local public utility company called Black Hills Energy signed a deal to provide power to a bitcoin mining operation in Cheyenne for at least five years. According to the agreement, customers who opt to use their electricity at ideal times for the utility company will receive a $2 credit adjustment per kilowatt hour. 

That means users can shut off or minimize their electricity usage during the company’s peak hours in exchange for cheaper power, similar to an agreement between Texas-based crypto miners and the Electric Reliability Council of Texas, which sometimes pays large electricity consumers to reduce or cut power consumption during heat waves or other periods of high demand.

Another key piece of Wyoming legislation now authorized special purpose depository institutions (SPDIs) to be charted by the state that provides basic operational infrastructure like insurance and fiat-to-crypto banking services to these firms. The language distinguishes this type of institution from banks, as they cannot offer loans and must maintain 100% reserves as well as keep a contingency account, which allows for three years of grace before requiring 2% of depository liabilities be kept as contingency for unexpected losses.

Now, Wyoming law at least provides clear guidelines to follow, and offers a glimpse of lawmakers taking steps in the right direction in their approach to crypto adoption. Nebraska is a notable example which has passed similar legislation recognizing SPDIs, following in Wyoming’s footsteps. Arizona has also granted permission for SPDIs to operate with the same “rights and immunities as comparable in-state banks.”

The new laws also created a novel mechanism for crypto banks in the state to be treated as “qualified custodians” of crypto assets as applied to securities laws. This means that owners of crypto assets don’t need to relinquish ownership rights when depositing crypto with one of these Wyoming crypto banks. 

Distinguishing language for non-fungible tokens, private keys, multisig arrangements, and asset custodianship is extremely DeFi friendly as it gives users and institutions the peace of mind that the ownership arrangements they engage in won’t come back to create trouble in cases of dispute or subsequent punitive actions by the state. 

Instead, the law defines such arrangements as bailments, which legally means deeposited crypto is simply being held for safekeeping by SPDIs as legal custodians. First venture capital and then institutional players will find Wyoming an attractive place now that banks may hold crypto assets as bailments in a legal jurisdiction providing fertile ground for innovation. Unfortunately, SPDIs are not fully operational until they have direct access to the global fiat banking system via accounts with the US Federal Reserve.

Wyoming SPDIs and Their Status Quo Woes

Wyoming’s special purpose depository institutions have almost everything they need to gain institutional adoption. You may have heard of them: first was Kraken Financial, and then Caitlin Long’s Avanti Financial, recently changed to Custodia Bank. To date, these institutions have received state banking charters, hired and built teams of professionals, ironed out their technical infrastructure, and even received their American Bankers Association (ABA) routing numbers.

Nevertheless, there is still a major obstacle preventing them from accessing the top tiers of the banking world, master accounts at the US Federal Reserve. In 2021, the Fed proposed a process to weigh how it might incorporate SPDIs and similar institutions into its existing payment system, which would also provide the framework for insuring their depositors’ fiat and digital assets. SPDI aren’t required to obtain FDIC insurance to protect depositors’ assets, but may opt to do so.

Recently, Custodia Bank logged an official complaint against the Federal Reserve Board and the Federal Reserve Bank of Kansas City in Wyoming federal court, alleging that both are unlawfully refusing to act on Custodia’s application for a master account with the Fed and thus harming their interests.

Custodia asserts in the complaint that because it is eligible for federal deposit insurance it is also therefore eligible for a master account, which it applied for back on October 29, 2020. Custodia also noted that the delays it experienced in applying for a master account has caused it to launch its products using a third-party bank, creating a more expensive and less streamlined experience, and all but eliminating the competitive edge it offers as a SPDI offering services for digital assets.

The Federal Reserve Board has been sued regarding master account access before. Previously, a credit union formed to serve state-approved marijuana-related businesses sued the FRB of Kansas City when it had been denied approval for a master account. In January 2016, the court declined to grant the applicants access to a master account and dismissed the case with prejudice, citing the illegality of marijuana activity under US federal law.

Additionally, in 2018 TNB USA Inc. sued the Federal Reserve Bank of New York alleging that it has been unfairly blocked from opening a master account, forcing it to use intermediary banks. The claim was eventually dismissed because no official denial had been given, but in 2021 the Federal Reserve issued proposed guidelines supplemented for evaluating account requests, though TNB has yet to gain access to the Fed’s payments system and lower interest rates.

Another hopeful milestone came on June 7, 2022 in the form of the Lummis-Gillibrand Responsible Financial Innovation Act, which introduced provisions on digital assets and laid out an agenda for regulating crypto businesses. In the proposal, stipulations are made that state-chartered depository institutions are to be entitled to Federal Reserve master accounts, spot crypto asset exchanges are to be permitted to register with the CFTC, the classification of income from staking or minting proceeds, and gives permission to issue stablecoins to depository institutions.

The Fed had already been reluctant to grant master accounts to crypto banks, even before the latest meltdowns plaguing crypto of late took place. Fed Chair Jerome Powell has cited concerns over setting a precedent for allowing other crypto banking firms access to master accounts. Specifically, the stated worry is that banks without FDIC insurance to backstop counterparty risks, unexpected defaults or market volatility, or other risks which could be unique to digital assets might grow too important before failing, and eventually needing some sort of bailout.

US national debt clock- july 2022
While the Federal Reserve is rightly concerned with the operational security of crypto banks and the risks they may pose to the global financial system, it is important to keep in perspective the sort of unfunded deficit spending that they will permit in other instances.

To be fair to J. Powell and the Fed, staying up to speed on the latest Web3 tech is not exactly easy, and the Fed definitely doesn’t see itself as being obligated to relinquish any of the control it currently wields over global banking and trade. However, with the US national debt pushing $31 trillion dollars and the Fed’s complete and utter acquiescence to bailing out its unfunded debt liabilities, Powell’s use of potential bailouts and other hypothetical worst-case-scenarios as reason to prevent crypto banks from getting master accounts seems inconsistent and even raises eyebrows regarding the prospect of chicanery. Let us not jump to the worst conclusions just yet, as co-existence is likely to be the only path forward for the foreseeable future, and time may prove that optimism and patience pays off in the long run.

Though Wyoming offered the first bank charter outlining how financial regulators would supervise digital assets in the US, their counterparts abroad have been ahead of the game in several instances. The city of Lugano in Switzerland, for instance, began offering similar licenses for crypto banking in 2019 and continues to draw in massive investment numbers for their expansion to operate in places like Hong Kong, Singapore, Luxembourg, Abu Dhabi, and many more.

Nevertheless, the state’s move to kick-start crypto banking in the US is significant when compared with the sluggishness of other states of the union. Some have even compared the move to South Dakota when its government moved to remove credit card interest rate caps, which subsequently opened the door to Citibank moving its credit card operations there.

Though many have voiced opposition to credit card companies jacking up rates after setting up shop in South Dakota, proponents say the move helped turn Sioux Falls into a diverse and flourishing city with a burgeoning middle class, and a banking sector with assets measuring in the multi-trillions. It is doubtless that the economy has diversified significantly away from agriculture, which was and arguably still is their reputation to this day. 

What’s more, moves to make crypto assets like Bitcoin into legal tender for payments has also been proposed in both Arizona and in Wyoming, similar to what’s already been implemented in El Salvador, Lugano (Switzerland), and most recently in the Central African Republic. Of course, this is likely to create friction points for adoption by making central banks and other authorities become even more defensive in their stances towards digital assets, which is not conducive for creating a space for the new technology to thrive. No doubt there are political forces at play as well, meaning politicians or other fiat-banking incumbents could leverage their influence at various regulatory bodies to stall progress or selectively enforce punitive measures against certain firms.

Key Takeaways

Advocates for decentralized systems often do so without a comprehensive understanding of why it’s important aside from incentivizing transparency and fair play. By allowing some states to experiment with digital assets and other emerging technologies, financial and legal systems permit innovation at the margins without threatening their core foundations. It also permits healthy, creative destruction to take place so that our systems do not stagnate and become corrupted or otherwise choke off innovation through centralized control. 

Incumbent players do not particularly favor competition nor innovation since they often expend resources trying to limit their competition. This is a fatal error since excess resources should be invested into profitable enterprises like innovation, maintenance, or even human capital. It is at the core of why decentralization is a preferable and more sustainable characteristic to have in nearly every aspect of commerce, since it so eloquently mimics the way living beings evolve in the world by imitating past iterations, and simply adjusting at the margins in response to our environments.  

Instead of storming the Fed’s beaches like it’s northern France and circumventing the use of the US dollar, it is most prudent to proceed cautiously in lobbying for legislation which permits digital assets to co-exist alongside fiat systems. By creating solid Web3 infrastructure and demonstrating its value via the free markets and existing long enough for users to take notice, the move to crypto rails will seem natural and obvious to all rather than some transition which the system must undergo.

It will just happen once the consensus view is that Web3 is more transparent, efficient, and secure than alternatives. As the story goes with the Trojan horse of antiquity, the Trojans eventually let their guards down and fell asleep, allowing the Greeks to sack the city of Troy and win their war. While crypto adoption is not exactly a war, it is the strategy which should interest us the most; if your goals are being prevented by a strong and determined opponent, create opportunities for them to let their guard down.


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