Custodia is leading a one-bank crypto crusade against the Fed and reviving claims of Operation Chokepoint 2.0

Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insights on policy and regulation.

Remember Operation Chokepoint 2.0? The narrative feels like a distant memory, buried by competing storylines like the Sam Bankman-Fried trial and the race for the Bitcoin ETF, but it dominated the crypto airwaves just a few months ago.

After the collapse of FTX in late 2022, leaders of the crypto industry began to argue that firms associated with digital assets were getting cut off from banking access in an effort coordinated behind the scenes by the highest reaches of government, from the Federal Reserve to the Treasury Department. This culminated in the mini-banking crisis of March 2023, which felled several crypto-associated banks and the 24/7 payment networks like Signet that powered the industry.

Parts of the Operation Chokepoint 2.0 argument always rang true, as different federal agencies began to issue warnings and crack down on crypto after the spectacular collapses of some of the sector's biggest projects. Other parts did not: All of the regulatory actions, after all, were happening in the public eye—that was the point.

One of the companies at the center of the Operation Chokepoint 2.0 narrative says it has new evidence that proves its existence. Caitlin Long, the founder and CEO of Custodia Bank, has been at war with the Federal Reserve for years. With a Harvard Law degree and a Wall Street background, Long has been on a crusade to create a blockchain-focused bank since 2016, going so far as to lobby the Wyoming state government to create a specific digital asset banking structure. The brainchild of the campaign became Custodia, which would offer crypto products like Bitcoin custodial services, as well as its own stablecoin.

Long's plan hit a snag when the Federal Reserve Bank of Kansas City, which oversees Wyoming, wouldn't approve a master account for Custodia, which would grant it access to key Fed payment services like inter-bank transfers. Since 2022, Long and Custodia have contended not only that the Fed was compelled to grant her, and any eligible institution, a master account, but that the Federal Reserve's Board of Governors has conspired against Custodia because of its crypto-first approach, pulling the ostensibly independent Kansas City Reserve Bank's strings to guarantee a rejection. In an ongoing lawsuit, a judge found it plausible that the Board of Governors "had at least some hand in controlling" Custodia's master account application.

The legal arguments in the lawsuit are complex—for example, whether the Kansas City Reserve Bank is a federal agency, and whether the Fed has the discretion to deny a master account to eligible institutions—but the interesting details here are the Board of Governor's efforts to derail Custodia's efforts. Ensuing discovery compelled by the court produced new evidence about the coordination, Custodia alleged in a late December motion, describing the affair as a "David and Goliath story."

For example, Custodia's motion details the level of involvement Board staff had in guiding Kansas City to rejection, including helping draft the eventual memo. Custodia presents a deposition with Esther George, then-president of the Kansas City Fed, as a smoking gun, with George admitting that she was unaware that the Board had made edits, additions, and corrections to the memo, assuming it was instead done by her staff. Even so, George seems nonplussed by the revelation in the deposition itself, citing the novel nature of Custodia's application and the need for Fed guidance.

The thrust of Custodia's argument is that its application would have been approved if not for the Board of Governors' meddling, which itself was prompted by the FTX collapse and eventual fallout and "choreographed" with anti-crypto statements by the White House. "The behind-the-scenes plotting does not reflect well on the Board," Custodia writes in its latest motion.

While a spokesperson for the Federal Reserve declined to comment for this piece, its argument seems clear. Even if Custodia does not engage in the type of banking practices, such as lending, that sunk Signature and Silvergate, crypto still presents a clear and documented risk. Long has spent years devising a structure that would allow a digital asset bank entrance into the Fed system, which it rejected through established channels.

Crypto advocates poring over Custodia's 64-page motion will instead find further proof of Operation Chokepoint 2.0. Presented in a different light, Long worked with a state government to create a new legal framework for crypto banking that should work with the Fed model. Instead, the Fed rejected its innovative approach, in a potentially illegal manner.

Coinbase's lawsuit against the SEC gets the lion's share of the headlines, with some legal analysts predicting that it could go all the way to the Supreme Court and defang several federal agencies. Custodia's petition could be just as consequential.

Leo Schwartz
leo.schwartz@fortune.com
@leomschwartz

This story was originally featured on Fortune.com