BTC166: Bitcoin Custody For Institutions w/ Caitlin Long and Wes Knobel
BTC166: BITCOIN CUSTODY FOR INSTITUTIONS
W/ CAITLIN LONG AND WES KNOBEL
23 January 2023
Join us in this insightful episode where Caitlin Long of Custodia Bank and Wes Knobel delve into the innovative non-fractional reserve system, the challenges faced with the Federal Reserve, and the dynamic world of cryptocurrency banking. They discuss Custodia’s unique approach, its role in the post-Silicon Valley bank crisis landscape, and the evolving challenges and opportunities in cryptocurrency custodianship. This conversation offers a deep dive into the intersection of traditional banking, regulatory environments, and the growing influence of digital assets.
IN THIS EPISODE, YOU’LL LEARN
How Custodia Bank is redefining traditional banking practices.
The significance of Custodia’s approach to customer deposits.
Insights into the Federal Reserve’s decision-making process.
The implications of non-participation in fractional reserve banking.
Caitlin Long’s expertise in banking risks and legacy systems.
Wes Knobel’s perspective on financial innovation and regulation.
The recent SEC approval of Bitcoin ETFs and its impact.
The potential government intervention in cryptocurrency holdings.
The importance of state laws in protecting digital assets.
Predictions for the future of banking in the era of digital currencies.
Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.
[00:00:00] Preston Pysh: Hey everyone, welcome to this Wednesday’s release of the Bitcoin Fundamentals podcast. On today’s show, I have back the super thoughtful Caitlin Long and she’s joined by Mr. Wesley Knobel and we’re talking about all things institutional custody. Now, for people that have been watching the Bitcoin ETF news, you know that the floodgates have been opened up to a whole new tranche of trillions in capital.
[00:00:25] Preston Pysh: But, where is all this Bitcoin be in custody? More importantly, what type of risk does all of this consolidation and custody have on these products? I promise you, this is a mind blowing conversation, so make sure you hang around until the very end because there’s some really juicy stuff and important nuggets there near the end of the discussion.
[00:00:43] Preston Pysh: But with all of that said, here’s my chat with Caitlin and Wes.
[00:00:50] Intro: Intro: You are listening to Bitcoin Fundamentals by The Investor’s Podcast Network. Now for your host, Preston Pysh.
[00:01:09] Preston Pysh: Hey everyone, welcome to the show. I’m here with Caitlin and Wes. Guys, it is such a pleasure to have you here and to be talking about, in my opinion, a super important topic right now. So welcome to the show.
[00:01:20] Caitlin Long: Hey, thanks Preston. And welcome Wes.
[00:01:24] Preston Pysh: Yeah, welcome Wes. Welcome. Tell us a little, real fast Caitlin tell us a little bit about Wes so he doesn’t have to do this for himself.
[00:01:33] Caitlin Long: All right, Wes and I are both at Custodia Bank. We announced in November that we had launched Bitcoin Custody. In October, we are live. We have taken our first very substantial customer in house. Wes, I can brag about, comes from the banking industry. You’re going to hear that as a team here. We are Bitcoiners and bankers at Custodia.
[00:01:55] Caitlin Long: We were able to hire Wes from Silvergate. He has an applied math background. He is a cryptographer and he also went to Pacific Coast Banking School, spent 12 years in the banking industry. and was in charge of operations for Silvergate’s digital asset business. So this was the margin calls on the Bitcoin backed loans, as well as got involved with Silvergate’s project on the stablecoin, which ultimately didn’t take off.
[00:02:22] Caitlin Long: And we were able to grab Wes, and he’s our VP of Bitcoin Custody. Those of you who are engaging with us on Bitcoin Custody already know him. He is one of our customer facing people at Custodia.
[00:02:34] Preston Pysh: Here’s where I want to start this conversation off. So if anybody’s paying attention to this space, the one thing that is just relentless these days is the ETF.
[00:02:44] Preston Pysh: And my biggest frustration with this ETF is how it’s being custodied and how it’s being funneled on, not all of them, but most of them are going with just one custodian. And when I’m thinking about the risks of this, I don’t like it as a Bitcoin. I mean, you, everybody will say not your keys, not your coins.
[00:03:07] Preston Pysh: Take self custody if you can, but there’s, there’s numerous situations out there as this thing continues to mature, just with the laws and regulations that are out there, that that’s not an option for a lot of people. When we look at this and we want to de risk it, the custody is so important. And I want to start off with an idea that you have championed, but I think a lot of people don’t hear the message, and it’s a word called bailment.
[00:03:33] Preston Pysh: Teach us what bailment is, why it’s so important, why 2019 was a groundbreaking year for this term, specifically in Wyoming, but for anybody. That’s participating or needing some type of custody service. Lay this on us. This is vital. This is so important. And I think it’s at the core. I suspect it’s at the core of your Custodial bank.
[00:03:57] Caitlin Long: Yeah. Let me start and then hand it to Wes. Drew Hines has on it has his pin tweet something like, not your legal title, not your coins. Yes. And it is a play on not your keys, not your coins. Wes and I are both adamant. that unless you need to use a third party custodian, you should not. So you won’t see a lot of custodians say that, but we’re here because there are a, there are a number of businesses, fiduciary businesses, anyone subject to the investment.
[00:04:27] Caitlin Long: Advisors act or the investment company act that has a requirement that an asset manager store their custodian, have a third party custodian hold the assets for them. That goes back to a lot of fraud that happened in the mutual fund industry in the 1930s. There’s a segregation of fund management and fund custody.
[00:04:44] Caitlin Long: And we are just fund custodians in that, in that regard. Bailment. What is a bailment? It’s valet parking. It’s a coat check. You don’t turn over a legal title to the custodian. When you park your car in a valet parking garage, or when you, when you turn in a nice, let’s assume you have a fur coat, you’re not turning over legal title to the restaurant when you check it at the coat check.
[00:05:07] Caitlin Long: All you’re doing is giving temporary possession of those assets. And that is a very important legal, legal framework that the Wyoming Special Purpose Depository Institutions recognize. Now, you point out that the custodians, there are a couple of different ones. What do they all have in common? Most, it’s mostly Coinbase, but of course, Fidelity.
[00:05:29] Caitlin Long: And there are a couple of others as well that are smaller that are among the custodian list. Every one of them is using a trust company structure. Custodia is a bank. There is a difference. And the biggest difference, there are several actually, but the biggest one is that banks cannot be dragged into federal bankruptcy court.
[00:05:48] Caitlin Long: They are expressly excluded from federal bankruptcy court. What is the significance of that? We saw it in Prime Trust, we saw it in the Celsius bankruptcy. Celsius was not a trust company, but Prime Trust was, and is. And what happens is, in the Celsius, that’s a perfect example, even though they weren’t a trust company, the judge said there’s a constructive bailment of the custody assets.
[00:06:12] Caitlin Long: So those belong legally to the custody customers, but because they were intermingled in that legal entity with non custody customers, there were preferences and clawbacks that had to be cleared before the custody customers could take their money. So the committee of custody customers agreed to take 72 cents on the dollar just so that they wouldn’t have to wait years through the bankruptcy process.
[00:06:41] Caitlin Long: What we saw in the case of Prime Trust is that the state charter trust companies, Nevada Trust Company, they started down a state receivership, which is generally going to be more favorable to the customers than bankruptcy. Federal Bankruptcy Court is designed to maximize the assets for the estate. It’s not designed to maximize the assets to the customers.
[00:07:01] Caitlin Long: Big difference. Okay, so it started in receivership, but then it all ended up in federal bankruptcy court. And now there’s a Chapter 11 process. We don’t know what the haircut’s going to end up being. But there is a perfect example of where a trust company ended up not being able to deliver on an actual bailment.
[00:07:20] Caitlin Long: This is the fundamental reason why in the securities industry, the custodians are banks, almost entirely banks, because the bankruptcy treatment is really clear. Now, here’s the funny thing. I’ll end with this, and then we can get into the structure of Custodia’s arrangement, because this legal structure that I’m describing had a big impact on how we designed our technology.
[00:07:45] Caitlin Long: So I’ll kick it over to Wes in a minute. But here’s the funny thing, Preston, you’ll laugh at this. I haven’t talked about this publicly yet. I sit back and look at the fact that we had some big banks like Bank of New York Mellon announced that they were getting into Bitcoin custody, right? Some of the big guys were coming for this industry.
[00:08:00] Caitlin Long: And then the SEC implemented SAB 121 that said, oh, for Bitcoin, that’s different than securities. Bitcoin custody has to, you, you have to put your assets on balance sheet, which means if you’re a bank, it’s going to attract a tier one capital charge. Well, it’s only the SEC public filers that SAB 121 applies to.
[00:08:19] Caitlin Long: So here’s the funny thing. I think the SEC looked at that as a firewall against the crypto industry and said, we’re going to keep these big banks out of crypto. They’re in it. It’s just that they can’t grow billions and billions and billions of dollars. So I don’t even know if those big banks that are in custody even competed for the Bitcoin ETF custody because they would have to hold say eight percent of every dollar under custody in capital. It starts to become extremely expensive, right? They have custody businesses. They’re just not as big as they otherwise would be had the SEC not implemented SAP 121. So now you see where I’m going.
[00:08:53] Caitlin Long: Yes. Here’s the funny thing. Coinbase is by far the biggest custodian of the Bitcoin ETFs. Yeah. And it’s a company the SEC was suing. But because of SAP 121, guess what? The crypto industry, namely Coinbase and Fidelity, are the custodians on the ETFs. That is, I’m sure, not what the SEC would have preferred.
[00:09:14] Preston Pysh: Wow, that’s crazy. That’s crazy. Wes, any other additional highlights on that particular topic? Yeah.
[00:09:21] Wes Knobel: Well, just when I think about our solution, we really extend that bailment concept into the structure of our account set up as well. So those assets are segregated on chain. We don’t do any omnibus customer pooling.
[00:09:33] Wes Knobel: So customers can see their funds on chain in any time. Their UTXOs that they send us are bound to them and them alone. So that ensures that that complete segregation on chain is visible for them, which is a really important point I think we want to drive home. And this maximizes the customer projections and transparency for those funds on chain and that legal bailment structure really accentuates that, that product offering.
[00:09:56] Preston Pysh: Wow. I’m a little speechless.
[00:09:57] Caitlin Long: We do UTXOs.
[00:09:58] Preston Pysh: Yeah, yeah, that’s, that’s been a hot topic. That’s what Lisa Huff likes to talk about, right? We custody UTXOs. Others will custody Omnibus Bitcoin. We custody the actual UTXOs. There’s your difference.
[00:10:10] Preston Pysh: Yeah. That tells you everything. And so for people that aren’t familiar with some of these terms, just think of UTXOs almost like the, like if you had physical cash and coins and there was a dollar and 87 cents, and there was, it was made up of two pennies and this many dimes and this many quarters, you can see exactly what the composition of that account balance is by the sheer physical, I’m calling them coins in that account.
[00:10:36] Preston Pysh: And so if it wasn’t Omnibus and you were mixing them all together, you would have no clue that that, that that account over there belongs to Preston Pysh or whoever the person might be that, that’s the UTXO is attributed to. Guys, this is really exciting. So I, I think the, if I’m putting myself in the audience’s shoes, I think they’re probably saying, okay, so why isn’t all these ETFs using Custodia right now?
[00:11:00] Preston Pysh: Does it have to do with the timing of them trying to get their ETF approved? And maybe some of them are going to transition over. Like what’s the, how are you guys looking at this moving forward into the coming year?
[00:11:10] Caitlin Long: Well, we did have one of the ETF managers reach out to us and a lot of it is timing. And this is one of the unfortunate realities of what happened with custodian vis a vis the Fed.
[00:11:21] Caitlin Long: Because we got our certificate of authority to operate in September of 2022. And then after the denial and the disparagement, it took us longer. I’ll leave it at that. A lot will eventually come out about what happened in that interim period, but especially if there’s ever a damages portion of our trial.
[00:11:37] Caitlin Long: But obviously we got delayed and unfortunately we had a lot of, we had to pull engineers off. The custody project and product people off the custody project to do a lot of other things that needed to that we needed to rebuild during that time frame. So long story short, yeah, it took us longer. And here we are, though, we survived it.
[00:11:56] Caitlin Long: A lot of. Companies that were trying to go down the same path as Custodia did not survive it. But, when push came to shove, the reality is we’re too new. And it is true that the other custodians have been around for several years. And that makes a difference in the securities industry. But we’ll get there.
[00:12:12] Caitlin Long: I’m not worried about it. We’ve got other niche markets. The ETF market, of course, is a big one, but we’ve got other niche markets. Some of our customers are looking at us as a diversification. This is something new. It used to be there was really only one or two custodians that were deemed secure.
[00:12:31] Caitlin Long: That’s no longer true. There are others as well, but there’s a desire because folks are starting to understand that there are differences in the custody architecture and operations that they want to diversify. And so some folks are starting to diversify away into us.
[00:12:47] Preston Pysh: I want to talk about the delay, but I want to ask it, or I want to bring up that point after this really simple question.
[00:12:55] Preston Pysh: When you’re looking at the custody of this, there’s a lot of people that now are saying that they’re fearful of a 6102 attack on all of these treasuries. So let’s fast forward two, three years into the future. Bitcoin is super successful. We’re looking at the sheer size of these treasuries. There’s hundreds of thousands, maybe millions of Bitcoin inside of these, these treasuries at these custodians.
[00:13:21] Preston Pysh: And there’s a lot of people muttering. All right. So the government has figured out that Bitcoin is taking over. And they pull a 1930s 6102 and they basically take all the Bitcoin out of these treasuries and they stuff fiat cash into the hands of, of the individuals. My question for you, as it pertains to this HB 74 that was passed in the state of Wyoming and different states that are doing everything that they can to protect themselves against such federal overreach.
[00:13:54] Preston Pysh: Help us understand what that scenario that I described, how would you see something like that playing out? Are there states rights that will really protect the end users? Help put us at ease here, I guess, is what I’m really asking.
[00:14:07] Caitlin Long: Well, I mean, the reality is we are, I’m sure, in the United States, okay? So, if you are worried about that, obviously, as a U.S. domiciled corporation, we are a state of Wyoming corporation, and a U. S. taxpayer, yes, if they use the tax code to effectively effect a 6102 confiscation of gold again, and it happens to be the confiscation of Bitcoin this time, yes, I mean, this is one of the issues of using a third party counterparty that is regulated.
[00:14:37] Caitlin Long: A third party counterparty that is regulated has to comply with the laws, whether you agree with them or not, you have to comply with the laws, and that is what your charter requires you to do. Now you’re asking an interesting question that relates to the fact that we’re a state chartered bank. It is public information that Custodia applied to become FDIC insured, and the answer was essentially, hell no, and we knew that, we knew that, frankly, Wyoming designed the Special Purpose Depository Institution Charter back in 2017 precisely because we knew that Operation Chokepoint 1. 0 had caused a lot of legitimate crypto companies to lose their bank relationships, and if you go back far enough, actually, in crypto history, one of the reasons that Coinbase broke out from a number of the early payment platforms, which is what it was back in 2013 ish. One of the reasons they broke out is because they lost their bank account at Silicon Valley Bank.
[00:15:30] Caitlin Long: This is all public information. And they were able to replace that bank account with Cross River pretty quickly. And some of the other companies that were U. S. based ended up going offshore and focusing offshore because they couldn’t do that. And so Coinbase then became the 10 ton gorilla, right? What was the distinguishing feature?
[00:15:50] Caitlin Long: It was that 10 years ago, they were able, even though they lost a bank relationship, to replace it quickly. Whereas others couldn’t. And so this has been a perpetual issue in the industry for a long time. So long story short, here’s where I’m going. Some folks would look at it, at Custodia not being FDIC insured, as a feature, not a bug because it means the FDIC does not have jurisdiction over us. So we tried, we tried to become federally regulated and we’re rebuffed. So now you’re asking a really interesting question peering into the future. Is that going to make a difference? It very much depends, right? Our lawsuit, as you know, is over whether, over the Federal Reserve’s denial of Custodia’s master account.
[00:16:34] Caitlin Long: Custodia also applied to become a Federal Reserve member bank, which would have made us federally regulated by the Fed, and we were denied.
[00:16:42] Preston Pysh: That’s kind of interesting that, that somehow the universe has a way to kind of put up roadblocks when it doesn’t want you to go a certain way. Now, I don’t know if that’s necessarily what’s playing out here, but it would be interesting if, if maybe that was serendipitous, I guess.
[00:16:57] Caitlin Long: It’s kind of funny. It’s like the SEC putting up SAB 121 to keep the big banks out of custody and then Coinbase and Fidelity get all the custody business. I’m quite sure the SEC is not happy about that. It can’t be. I’m happy about that.
[00:17:11] Preston Pysh: I just want to so I know you are not allowed to talk about this ongoing case, which is the result of, for people that, that are in this space, they know that you were trying to do this for a very, very long time, years Caitlin.
[00:17:26] Preston Pysh: They also know that there’s a, a case right now between Custodia and the Federal Reserve. Board of Governors at Kansas City. And I know you’re not allowed to talk about any of this. So in preparation for this discussion, I am going to talk about this because I want to talk about this. And everything that I can find, I was able to find documents online with dot gov addresses here to do a little bit of research.
[00:17:57] Preston Pysh: I know you can’t respond to this. I know you’re not allowed to say anything as I’m talking, but I’m going to talk and I’m going to kind of lay out my opinion on what’s taking place here.
[00:18:06] Caitlin Long: All right, Wes and I will keep our mouths shut. Okay, don’t even. We’ll say, we are operating in spite of the fact we don’t have a Fedmaster account.
[00:18:12] Caitlin Long: Yeah. That’s, that’s really important to know. We are, we are operating. That did not kill us. But now over to you.
[00:18:19] Preston Pysh: Well, my frustration, and this is laid out in the documents that I read online, is just the delay and how that has impacted your business economically to even do what you’re doing right now, which I think is a massive highlight.
[00:18:32] Preston Pysh: And I think it’s, I think it’s other bankers playing very dirty in the politics. And I’m of the firm opinion that you have government lobbying and big wall street banks that are basically joined at the hip and working together. And these are not your words. These are my words as a podcast host. I’m just going to throw that out there.
[00:18:54] Preston Pysh: But when I go through this and I lay out like everything that I’m seeing, I think that there’s some worthy, very worthy highlights. First of all, is the delay in the decision making that they were getting ready to make a decision. Then all of a sudden they didn’t. And it was all these miscellaneous things that they brought up, inconsistent treatment, political influence, legal compliance, the impact on the, on the business, the innovation stifling that they did.
[00:19:16] Preston Pysh: Again, the economic implications, regulatory clarity, that seemed like it was very clear, then all of a sudden they changed their mind on some of this stuff. So like, just on the inconsistent treatment, there were overlaps in reviews, there was violations of federal law, rules, policies, and procedures that are very clear.
[00:19:35] Preston Pysh: In fact, the legal case that I saw had 23 different violations of federal laws, rules, and policies, and procedures that the Federal Reserve conducted against. your bank. They had changes in the reserve bank memos. They had guideline implementations in tier three and institution changes. The list goes on and on and on.
[00:19:56] Preston Pysh: Like, I mean, it is really long. And I think that this, for anybody listening to this, I guess here’s my point in laying all this out. If you’re in politics, or you are sitting in some type of financial chair in DC, I’ve never seen something so corrupt personally, right, as reading through this document. It’s a very long document.
[00:20:21] Preston Pysh: It is, there is a ton of information that’s laid out in here and there’s no way anybody could read this and think that there wasn’t foul play going on. So if there’s somebody listening, please take an interest in, in this because boy, oh boy, what, what a joke. And here’s the, here’s the irony for me. This is one to one.
[00:20:42] Preston Pysh: This is, this is what, and I’m sorry, I’m going off on a rant now, and I’m not even interviewing you, but I just have to put this out, this filing was for, if I put a dollar worth of buying power into this bank, that they are going to have one dollar there and not be lending it out. How in the world can anybody, in government, not one to approve something like this, especially in the face of the Silicon Valley Bank disaster that required more printing and more shoving of made up paper shrewd buck money into the hands of the people that are making all the mistakes in these fractional reserve games that just keep blowing up. It’s insane to me. It’s totally nuts. And I, and you know what? It’s very understandable because the game is rigged. We’ve all figured it out. We see it’s rigged. We see participants like the two here that I’m supposedly interviewing, but I’m not doing a very good job of it, sitting here trying to do something about it, and there’s just more corruption being played.
[00:21:45] Preston Pysh: So boy, you want to read, I’m, you know what? I’m going to post a link in the show notes to this filing so that if you want to read it and you want dig into everything that I saw in preparation for this interview, it’s going to blow your mind, folks. Blow your mind. So let’s go on to some real questions here. Sorry, I had to that off my chest.
[00:22:04] Caitlin Long: I’m going to quote Paul Grewal had a, had an incredible tweet in the face of all the SEC stuff relating to the ETF rollout. I am biting my tongue so hard it’s bleeding, okay? I’ll leave it at that.
[00:22:19] Preston Pysh: It is so frustrating, so frustrating. And so much of the changes, when you read through the document, what you’re going to find is, after the, so they were right up to approval, FTX happens, and it’s like, oh stop, everybody’s corrupt and everybody’s bad, so like, let’s not go in there with any evidence to adjust our position, just change the position.
[00:22:40] Preston Pysh: We were telling them that they were great in all these areas. But now they’re bad in all those areas because FTX blew up. And it’s like, give me a break. Like, give me a break. Let’s go line by line and quantify why they’re, they’re maybe not meeting whatever standard, even though you said that they were prior to all the other previous documentation and correspondence. It’s just, good Lord.
[00:23:02] Caitlin Long: Well, there’s, there is one thing that I can add because you brought up FTX. I had publicly disclosed that, that I had been handing evidence of probable crimes over to law enforcement in summer 2022 about one of the crypto frauds. It is now publicly disclosed in some of the documents that you just read apparently in preparing for this that FTX was the exchange that I was handing evidence of probable crimes over to law enforcement. I came into that, into possession of that evidence from someone who was able to get into their private chat rooms and came to me with it. I didn’t even review all of it. Once I reviewed a little bit of it and understood, oh my gosh, this has to go to law enforcement.
[00:23:43] Caitlin Long: I handed it to law enforcement. So there’s a double irony of the timing and all those references to FTX because I think it’s safe to say that federal regulators in Operation Chokepoint 2. 0 tried to paint everyone, including the law abiding parties, as, with the same brush as FTX. and they ended up sweeping out someone who was actively working with law enforcement to clean up the fraud.
[00:24:09] Caitlin Long: I am floored, and as a side note, at the attempts to rehabilitate Sam Bankman Freed. I knew all along that was a criminal enterprise.
[00:24:18] Preston Pysh: Yeah.
[00:24:19] Caitlin Long: And had the receipts for it.
[00:24:21] Preston Pysh: It’s very, very telling to see the books that are written about them, the interviews, the I’m sure there’s going to be movies. Oh, just, yeah.
[00:24:31] Preston Pysh: Let’s, let’s move on to the positive, the real building that’s happening.
[00:24:36] Caitlin Long: I’m going to have Wes talk about the platform because this is very cool. And it’s the kind of thing that presents Yes. The shenanigans we’re very, we’re talking about right now from occurring and hell, I mean, it’s, it’s obvious that if FTX had tried to become a U. S. entity, that all of the fail safes that apply to regulated financial institutions, even to money transmitters in the U. S. would have caught the fraud. And the fact that it was offshore, And there haven’t been authorized onshore parties is part of the reason why FTX was able to perpetrate the fraud that it did for as long as it did.
[00:25:12] Caitlin Long: But can we hand it over to Wes and he can talk about the technology? Let’s do it. It’s very cool.
[00:25:18] Wes Knobel: Well, we talked a little bit about the legal structure. Obviously, bailment is key here, but, you know, we took a lot of care and thought to build a solution in house. We utilize Bitcoiner experts in product engineering, security, compliance and operations.
[00:25:30] Wes Knobel: So that in house build really allowed us to minimize and mitigate our third party and counterparty risk, which is really a critical component for this space. So that the product we’ve developed kind of takes the benefits of cold wallet security with the speed and availability of warm wallets themselves.
[00:25:47] Wes Knobel: So considering those downsides, you know, both the cold wallet and hot wallet structures, cold wallet structures trust the people in the process. In a critical way, that means that they’re not resilient to personnel changes or issues around those personnel. So some custodians have been burned recently around those kind of, kind of concerns.
[00:26:06] Wes Knobel: The hot wall structures, while they’re highly available, also offer a really broad attack vector for nefarious actors, and we wanted to mitigate that. So we offered an alternative model. We thought, if there’s these two issues, why not take the best of both worlds? So how do we do that? So we employ cryptographically secured quorums, backed by tamper resistant hardware, which enables custodians to provide digital asset custody that features the security of those cold wallets with the availability and speed of a warm, warm wallet.
[00:26:32] Wes Knobel: In terms of what we offer we currently offer deposits and withdrawals for Bitcoin custody for institutional customers. So I think our solution is pretty straightforward and sound. There’s not a bunch of bells and whistles at this point, but we wanted to start slow and, and walk before we run.
[00:26:47] Wes Knobel: Love it. Ultimately, I can’t get too far into it, but we, we do trust cryptography in our process more than the people. And I think that speaks to, again, that Bitcoin ethos that we have here.
[00:26:57] Preston Pysh: So if say a customer wanted to custody one pair of keys or walk us through the key management very detailed.
[00:27:06] Wes Knobel: Yeah, certainly. So those keys are entirely with us. The customers never have to manage anything of that nature. For deposits, they just generate a deposit address and send that our way. Everything about that process is held in house. And we utilize kind of best in market back end for that. You know, part of our security controls is we’re not going to get too far into security controls in a podcast.
[00:27:26] Wes Knobel: So I don’t want to get too far into that. But certainly, we have monitoring, comprehensive logging, all of our infrastructure, network, and co base have been fully penetration tested. So all of that back end is well set up to custody those private keys, which are never extractable and nobody has insight into and uses it as a customer.
[00:27:46] Preston Pysh: So right now today, it seems like you have deposits in money market, BTC custody, and then USD payments is kind of the three services that you’re offering. Is any of those, or I guess the question would be, is there anything that you plan to expand beyond that or is that kind of what your focus is going to be here for the coming years?
[00:28:05] Caitlin Long: That’s definitely where we are right now. Two caveats. One is check our website because not all services are available in all states and I have to give the obligatory disclaimer that our deposits are not FDIC insured. So definitely look at our website for the appropriate disclaimers. So yes, the answer is we will be deepening the product.
[00:28:24] Caitlin Long: One question that came out, Preston, when you approached us about coming onto your show to discuss the custody platform is. Are we going to be offering trading services? So we talked a little bit earlier about the segregation of asset management and custody. I believe in the segregation of custody and trading as well.
[00:28:41] Caitlin Long: Because a lot of the shenanigans are, that have happened in this industry, happened because there was a combination of custody and trading. And so institutionally, again, any fiduciary is going to have to segregate those functions. And so that’s what we’ve built. We do not want to trade. We are not traders.
[00:28:58] Caitlin Long: We will offer integrations to exchanges and platforms that will provide trading services, but we will not, we will not be the trader ourselves. It’s in a way, it’s kind of, it’s like, you know, Bank of New York or State Street and the securities custody business being plumbed into the New York Stock Exchange or a NASDAQ or all the different trading venues, but they don’t trade themselves.
[00:29:22] Caitlin Long: If you want exchange services, you go outside of the platform, but the platform has an integration into those services. So that, yes, we are approved by the Wyoming Division of Behaviors and Public Information as part of our charter hearing that our business plan at charter did include those. We don’t have any announcements for anything yet.
[00:29:40] Caitlin Long: But stay tuned as, as Wes said, we’re walking before we’re running and as a new bank, you know, one of the funny things is it took us a long time after we applied to start Bitcoin custody to get the exam scheduled, much less done. Okay, that in and of itself, we disclosed that we applied for Bitcoin custody in April and we took our first.
[00:30:02] Caitlin Long: Deposit in October. Why did it take so long? Well, it takes time to get, to get an exam scheduled. Then you got to go through the exam. Then you got to get your letter. I wish it could have happened sooner, but it didn’t. And that’s okay. Because a bank is supposed to walk before it runs and is supposed to ask for permission, not forgiveness.
[00:30:20] Caitlin Long: And that takes time. You don’t want to move fast and break things as a bank. So yes, the answer is we will make those services available through our platform to our customers at some point. Stay tuned. We have not gotten approval to implement those yet, but it is on our roadmap and we will be deepening those, those offerings.
[00:30:40] Caitlin Long: As well as providing prime services, that’s another thing that’s publicly disclosed. Same thing, we’re just talking now about transaction services, basically, integrations into the exchanges. There will be integrations into the lenders for those who are interested in a directed, essentially, a securities lending model.
[00:30:59] Caitlin Long: We will not make those loans. Big difference. So Wes at Silvergate did that when Silvergate was a lending bank and was lending against Bitcoin as collateral. Custodia will not do that. We’re a non lending bank, but that doesn’t mean if you don’t want to get access to that, that you can’t. Sure you can.
[00:31:14] Caitlin Long: That’s the idea. It will just open up the integration to outside lenders. And then you would direct us just like your 401k administrator directs the custodian of the 401k plan to do certain things. You’d have the ability to direct us. to do that as your custodian. It’s very similar conceptually to the segregation in the securities industry that keeps a lot of the shenanigans from occurring.
[00:31:39] Preston Pysh: What do you guys, when you look at everything that’s developed over the last two to three years, and we look at where we’re at right now with this ETF approval. The large banks are coming on board. It sounds like we have some amazing custodians showing up. What are you most excited for in the coming year to two years with Bitcoin adoption and just the overall ecosystem?
[00:32:01] Caitlin Long: The deepening of the ecosystem. I’d love to hear Wes’s views on this because we’ve got a hardcore group of Bitcoiners in Custodia who are following all of it. And I think the deepening of the ecosystem eventually. A Custodial wants to be able to offer layer two payment services. That’s not to be clear on our approved roadmap right now, but we’ve talked about that.
[00:32:24] Caitlin Long: We’re watching the lightning network very closely. And of course, we want to be able to go to international customers as well. Right now, we’re only handling domestic businesses as customers. But I’m really excited about the layer two opportunities in Bitcoin and especially for merchants that are using this for cross border payments, especially Lightning.
[00:32:45] Caitlin Long: We’re watching that to a large degree, and it is also publicly disclosed that Casari was approved as of the charter for issuing a stable coin like instrument. There’s, we have not done that. We don’t have the final approval to do it. And again, we’re philosophically asking for permission, not forgiveness.
[00:33:05] Caitlin Long: And given what the Fed said. about us in, about stable coins, banks issuing stable coins. We’re waiting for some clarity on that before we proceed. But you know, what’s so interesting Preston, we’re recording this on the day that Howard Lutnick announced at, on CNBC during an interview at Davos that Cantor Fitzgerald is the custodian of all of Tether’s T bills.
[00:33:30] Caitlin Long: Yes, I did see that. fascinating? Yeah. Yes, okay, that is fascinating. I respect Cantor Fitzgerald a lot. Have dealt with them in my career, my earlier career, you know, they were one of the firms that was hardest hit by 9 11, many of their employees died in 9 11, so I have a special place in my heart for that firm for having survived it and 20 years later, still thriving.
[00:33:53] Caitlin Long: But what’s interesting is Counter Fitzgerald is a primary dealer, and that means because they’re not a bank, I looked it up today, there’s no Fedmaster account, they’re clearing all those US dollar payments. for Tether, just like all of their other customers, through a clearing bank. And I was looking to see who’s their clearing bank, and I found one reference to one of their clearing banks being Bank of New York Mellon.
[00:34:15] Caitlin Long: So here’s a really interesting, it’s coming full circle, isn’t it? It’s not okay for the crypto native companies to be doing this, but there’s a, there’s a big double standard, because apparently, The big incumbents are allowed to do this, but others are not.
[00:34:31] Preston Pysh: That is fascinating. I, you have some really profound thoughts around stable coins with respect to the, the risk that they impose on banking balance sheets.
[00:34:40] Preston Pysh: Because of how fast they settle relative to the legacy rails, can you describe this for people so that they can kind of really wrap their head around how profound and important this idea is? Because it’s almost like you’re dealing with one, the new world of finance, which is moving at the speed of light.
[00:34:59] Preston Pysh: And then you have this legacy finance system that’s moving at the speed of like the Oregon Trail, you know, Constantinople wagons moving around. And like they’re, they’re incompatible with each other, but, but break this down for people. Why are they incompatible? Why is this so much risk added to a balance sheet?
[00:35:17] Caitlin Long: Well, we saw it in fact at Wes’s prior employer, Silvergate, and Wes was working on the, on the stable coin project there. So I’d be interested in, in his views, but it’s fundamentally very simple. The US dollar system is designed, ACH settles one to three days. Fed wire can settle in TRA day, but you can’t program it to settle at a particular 1239 and 23 seconds, right?
[00:35:40] Caitlin Long: Something like that you can’t do. It’s not programmable Fed now is starting to get there, but the irony is that banks like us are blocked from using Fed Now, but we’ve got the technology to do it, so go figure. Anyway, it’s the difference in in settlement. Bitcoin settles. in 10 minutes, whereas I just described the settlement cycles for U. S. dollars. And one of the problems is that for a bank that wasn’t sitting 100 percent in cash, It’s clear that when the deposit run occurs, as happened in spades in March of last year, that took down several banks, four fairly large banks Silicon Valley, First Republic, and then Silvergate and Signature, that if they weren’t sitting 100 percent in cash, that those deposits could disappear very, very quickly.
[00:36:27] Caitlin Long: And it wasn’t just the crypto industry’s deposits, it was also just the tech industry’s. And I guess nobody, it didn’t occur to folks to upgrade the liquidity models for the fact that we could use one of these to withdraw 100 percent of our cash through online banking intraday if we’re willing to pay a Fedwire fee.
[00:36:49] Caitlin Long: And that’s what happened. So Wes, let me kick it over to you because you’ve lived this. You came from the banking world. Tell us your perspective.
[00:36:57] Wes Knobel: Yeah, I think the speed is really the paramount issue here. And frankly, it’s, as you said, the Oregon Trail versus lightning speed. I think that allowed for maneuvering, right?
[00:37:05] Wes Knobel: That allowed for adjustments to how we’re managing liquidity and things of that nature. Whereas if you have something at the speed of light, there is no chance to act. So it really exposes that fractional reserve model. And the framework that was set up that allowed for those maneuvers in the past that would not be possible in a stable point, I think, you know, kind of highlights the full reserve model that we operate under and how that really can work in a stable point setup.
[00:37:30] Preston Pysh: That’s such an important point that you added there, Wes, that I think I missed in my description. It’s not just the difference in the speed between the two systems. It’s also that one is fully reserved and the other one is grossly fractionally reserved. And when you’re, when the one that’s moving so slow is fractionally reserved relative to the other one, it only makes it more obvious when you get into one of these runs.
[00:37:54] Preston Pysh: Caitlin, I’m curious your opinions from a macro standpoint. So the TGA is being drawn down. It’s the, when we look at the backstop facility that was stood up for Silicon Valley Bank, it’s blowing out. There’s no way they’re winding this thing down anytime soon. These are my words, right? And so I’m just looking at like what options they have until that TGA basically zeroes out and it looks like they have to pivot very soon, like in the coming three months, they’re going to have to do some type of a pivot to be more accommodative and to add more monetary units into this game.
[00:38:24] Preston Pysh: Is that how you’re seeing it based on all your expertise, both you and Wes, all your expertise on traditional financial rails?
[00:38:33] Caitlin Long: Yeah, I’m looking at this and saying, I’m not sure how the Fed is going to unwind the facility that was designed to stop the bank run on small banks. There’s been a bank walk since then.
[00:38:46] Caitlin Long: I just posted yesterday a chart that was up in a Zero Hedge article, and I don’t fully agree with everything in the article, but the chart was stunning, and it’s correct. Which is that there has been a continued bank walk from the small banks and that without the Fed facility that was put in place last March, the small banks have less than five cents in cash for every dollar of deposit.
[00:39:08] Caitlin Long: And the large banks have had a lot of deposits flow from the small banks into the large banks. And they’re now north of 12 cents. Again, ponder how fast a bank run could occur at those banks. The Fed’s going to step in and provide liquidity. That’s its job, agree with it or not, but it is its job. And try to stem bank runs.
[00:39:30] Caitlin Long: That’s exactly what it did in March. And it did succeed. The question then is, are they going to be able to continue this? A lot of folks, if you look at March, basically the punchline is there are a lot of things that are lining up in March and the expiration of that facility, which had a one year period.
[00:39:48] Caitlin Long: As you say, the T the treasury general account, the reverse repo facility, and this is having. That, well, the, the Bitcoin hings in, in April, but I guarantee the Fed doesn’t care about that . The no, I’m talking just the internal plumbing of the Fed is this is the reason why the fixed income market, when you add all this up, is assuming that there are going to be rate cuts.
[00:40:12] Caitlin Long: But what’s fascinating is that if history is a guide, the rate cuts don’t start until there’s an accident somewhere. And what I would caution folks, you know, a lot of folks in the Bitcoin community assume that just because the Fed’s balance sheet is expanding, that that means that, you know, hyperinflation is around the corner.
[00:40:30] Caitlin Long: Be careful. It does not. In these kinds of scenarios, When the Fed’s balance sheet expands, they’re, they’re filling the bathtub that has drained out, if you will, they’re trying to prop up the total amount of credit in the economy and not have a debt deflation. And that’s why it doesn’t show up as, you know, high inflation or hyperinflation when the Fed does these things.
[00:40:51] Caitlin Long: Preston, I don’t know. I saw in that Zero Hedge article, they were tweeting out March, tweeting out that March is going to be lit and the March timeframe is going to be interesting. And to your point, overlay the fact that we’re going to have a halving in Bitcoin in April. That’s going to be interesting.
[00:41:08] Caitlin Long: And then we, of course, it’s a, it’s an election year, right? So you don’t, you know, when the Fed never wants to be accused of being anything other than independent. I’ll just state that as a fact. It doesn’t want to be accused. But anyway, it doesn’t want to necessarily sway the election in one, one way or another.
[00:41:27] Caitlin Long: And it’s perpetually, this is, this is a fact of history. Presidents put pressure on the Fed to ease during election years, period. And I’m sure that that’s one of the reasons why the fixed income market is assuming that interest rates are going to be coming, interest rate cuts are coming this spring. Wes, do you have anything to add on that?
[00:41:45] Wes Knobel: I think you summed it up perfectly.
[00:41:48] Preston Pysh: Yeah, no, it’s exciting. I think those are the, those are definitely the big dynamics. And I think the election piece of it is way more important than maybe what some have been talking about. I think that it’s, it’s a very big deal as well, that they need to be somewhat ahead of this.
[00:42:02] Preston Pysh: They definitely cannot have another Silicon Valley bank. deflationary event that’s kind of happening at the snap of a finger, like they have to be way out in front of that this, this year for sure. So yeah, I think they’re going to pivot. I think it’s maybe going to be a little earlier than people are expecting, or maybe they’re going to start easing into it and boy, it’s going to get interesting.
[00:42:21] Preston Pysh: And I agree, they’re not talking about the Bitcoin halving, but we are, and it’s going to be a big deal. It’s going to be a very big deal.
[00:42:28] Caitlin Long: Well, it’s so interesting because if you go back to the 1990s, I started my career in 1994 doing bank mergers. at Salomon Brothers. And there were twice the number of banks back then as there are today.
[00:42:38] Caitlin Long: There was a huge consolidation wave. Well, what happened after the 19, late 1980s real estate crash? Greenspan engineered a really steep yield curve, and that was designed to bail out the banks indirectly. Why? Because banks lend long and borrow short. And so they were earning a higher interest rate on their longer term loans because the yield curve was steep.
[00:43:00] Caitlin Long: Then they were paying on deposits, which they were borrowing short term. So they were doing their maturity transformation game and the Fed gave them an assist by steepening the yield curve massively in that time frame. The impact of that though, Preston, was that the number of banks got cut in half. So now the question is, we’re kind of seeing a rhyming because that, that BTFP facility for the small banks is designed to recapitalize the small banks.
[00:43:27] Caitlin Long: It’s risk free arbitrage. And that’s what for the small banks. And that’s what the, the Zero Hedge article was pointing out. They’re not wrong. And so it’s the analogy of the really steep yield curve that the Fed created, the Greenspan created in the early nineties to recapitalize the banks. That’s what BTFP has done to recapitalize the small banks, but it didn’t work.
[00:43:46] Caitlin Long: And there was a massive bank consolidation wave. And I think that’s probably going to happen again. Wes, do you agree with me on that?
[00:43:53] Wes Knobel: Well, absolutely. I mean, that trend has been going on for some time. So I think this only speeds that up.
[00:43:58] Preston Pysh: I don’t even think that it’s just banking. I think it’s across all industries that you’re watching the consolidation of, of enterprise.
[00:44:04] Preston Pysh: And I think that. If we were going to really kind of look at the cause and effect of all of this stimulus, all this inner intervention that’s been happening for decades, each cycle, it’s quote unquote saved, but what’s not discussed or what the cause and effect of that saving the economy is, is further and further consolidation of equity into the hands of fewer and fewer businesses.
[00:44:27] Preston Pysh: Yeah, I think that that’s, it’s a glaring example of it in banking, but I think that if you did go out into other industries, you would find the exact same situation is playing out across the board and across the globe, not just in the U. S., everywhere you look, because it’s just all so harmonized, all this, all this central banking activity that’s taking place is just completely coordinated together You can see it in the growth of the M2 and the contraction of M2 across the board, right?
[00:44:57] Caitlin Long: It’s so interesting because on that topic, Lynn Alden has a really interesting observation in her book. You guys come from a, you know, science background as she does as well. And I love the way that scientists think about this because It was really profound, her observation that what caused the, what caused money to kind of morph in its definition 50 years ago was because we went to 100 percent fiat standard all around the world and we’ve never been there before.
[00:45:28] Caitlin Long: And it’s the first and only time in human history that she alleges, and I think she’s probably right, I can’t think of an alternative, where good money was crowding out, bad money was crowding out good, where fiat currency, what, you know, crowded out the commodity money that was gold, and how, why is that?
[00:45:43] Caitlin Long: Because usually it’s the good money that’s crowding out the bad. Why is it that that happened? And her answer was that it was telecom. It was the ability to, for the data leg of transactions to move at the speed of light, and gold was money, and that was limited to moving at the speed of matter. And so it had to just keep getting abstracted away and abstracted away and abstracted away, and people just wanted the ability to move money quickly.
[00:46:10] Caitlin Long: And so the fiat money crowded out commodity money. Well, her thesis is the opposite is now coming full circle because Bitcoin is ledger money that’s not controlled by anybody. It is better money. I know there’s a huge debate as to whether it’s money or not. I won’t get into that. But if you just assume for the moment that it is a medium of exchange to at least some people, as opposed to just a speculative instrument.
[00:46:34] Caitlin Long: That it does move at the speed of light and it is harder money than the fiat money that we’re all using right now. And what is the impact of that? You asked early on what’s, what’s coming down the pike. I think that’s a pretty profound trend and I think her explanation of it is right. We haven’t had the ability to move a commodity money at the speed of light until Bitcoin.
[00:46:56] Preston Pysh: How incredible was that book, by the way?
[00:47:03] Preston Pysh: Broken Money is the name of this book. If you have not read this book, let me tell you, you need to get your hands on it. Caitlin, I want to ask you a question, the tokenization of like real equity. In your mind, if let’s take Apple or Google stock and it becomes tokenized so that it’s immediately saleable, The thing that I can’t get past is you’re, you’re always going to have to be dealing with stock certificates of who that equity, who the rightful owner of that equity is.
[00:47:31] Preston Pysh: Right. And when I look at blockchain, quote, I’m using blockchain and air quotes here. When I think of people that are saying, well, it’s going to be equities next and the heck you have a Larry Fink kind of running around this week talking in this, in this manner. When I think about this, I just don’t understand why banks can’t just set up their own networks with each other and say, Hey, here’s the ledger that the five of us agree is whatever, this is how many Apple stock we have today.
[00:48:03] Preston Pysh: This is how much you have. This is how many Google stocks we have. And when we exchange these things immediately on our ledger, we’re just going to, you know, swap the stock certificate into my name or your name. I just, I think that that’s kind of how this evolves. I don’t necessarily see this evolving in a decentralized way.
[00:48:22] Preston Pysh: What, what am I missing? Or I guess, why is that argument wrong? Or is there something that I’m missing majorly in that?
[00:48:32] Caitlin Long: It’s not, and we already have it, and it’s through the DTC. They electronically settle debits and credits. But here’s the thing. They’re using old technology, kind of like the ACH system.
[00:48:45] Caitlin Long: You settle your U. S. dollars in one to three days. Or Fedwire, you can do same day, but you can’t program it. The problem is the DTC has a similar constraint on the security side. And it goes to the root of the problem, which is that corporations are registered in analog form. If we could get corporate registrations at Secretaries of State to be done in digital form, natively digital, we’d solve all this.
[00:49:11] Caitlin Long: Because the easiest thing to do would be to have an API call to the Delaware Secretary of State’s office to verify that the share of stock that you’re buying was validly issued. And instead, what we have Is this, all these layers of abstraction that create, you know, naked short positions inherently. Why is it naked short positions?
[00:49:31] Caitlin Long: Because the systems on Wall Street are never in sync with each other. Never. That’s a profound thought. Why is it that they’re allowed to have all of these operational fault tolerances? And the answer is because the systems are never in sync with each other. So, I worked on this, I don’t know if you know this, I worked on this very problem.
[00:49:51] Caitlin Long: I was, the first blockchain project that I worked with the government was with the state of Delaware. The Delaware Blockchain Initiative in 2015. To try to get natively digital registrations of corporate, corporate stock. Wow. You know, okay, and I’m going to, I’m going to disclose something I’ve, I’ve, I don’t think I’ve ever publicly disclosed.
[00:50:09] Caitlin Long: I was working with a company called Symbiont. It was the president of the company and Symbiont was partnered with the state of Delaware for smart contracts and they were going to use the Symbiont platform to do corporate registrations and Symbiont’s engineers, who are by the way, Bitcoin engineers or early Bitcoiners, went in and started looking at the integrations and guess what they found, Preston?
[00:50:31] Caitlin Long: They found that the Delaware Secretary of State’s computer systems had multiple hackers sitting on the line. And disclosed it to the state of Delaware. And in return, how did the state of Delaware react? They shot Symbian. Okay, and I was a bystander to all of that. I wasn’t actively part of it. But I was the president of the company and I’m floored.
[00:50:54] Caitlin Long: So what does that tell you about what’s going on, right? Because there were people sitting on the Delaware Secretary of State’s system getting filings for mergers before they’ve been announced and the like. Okay, and so I shared that over the years with the SEC that you gotta look into this. And I don’t know if they have.
[00:51:14] Caitlin Long: But the reaction of the state of Delaware to learning that their system was insecure and had been hacked I was really surprised, but it was classic, you know, that the big registered agents and there’s one, one based in Delaware, very powerful. The previous governor was the one who was supportive of upgrading the IT system at the Delaware Secretary of State to allow natively digital registrations.
[00:51:35] Caitlin Long: Doesn’t have to be a blockchain, by the way, just anything that’s connected, that, that, that, where you can make an API call to verify that the share of stock you’re buying is legit. Then we could collapse all these layers and all these abstractions of in the security system that prevent the system from ever being accurate and ever being in sync with each other, but they didn’t want to do it.
[00:51:57] Caitlin Long: There were too many people making too much money off the old system that was inefficient. And where have we seen that? I just laid it out in securities. Have we not seen the same thing in banking? And, you know, look, I mean, those of us who are intrepid warriors on these kinds of things, part of the reason I switched over from working on the securities problem to the U. S. dollar problem is because I also realized we wouldn’t solve the securities problem until we solve the U. S. dollar problem. But actually the U. S. dollar leg is one of the reasons why the securities industry is still T plus two days to settle a stock trade. We’re going to T plus one in May, but the biggest reason historically, well, in the last 10 years was the U. S. dollar piece was so clunky.
[00:52:37] Preston Pysh: Well, when we look at going back to the discussion we had earlier, and we were talking about how the fractional reserve nature of fiat currency and the speed of settlement in contrast to Bitcoin exposes this massive issue for balance sheet liquidity. Do you see a similar dynamic with once this really starts turbocharging and kicking into high gear, which I think is happening here in this coming four years with Bitcoin and stable coins really kind of kicking into high gear, do you see that exposing some balance sheet issues with the failure of immediately settling real equity?
[00:53:13] Preston Pysh: Like Apple stock or Google stock as marketable securities on top of balance sheets. Is that an issue or is it a little bit more disconnected and not as much of a concern? No, it’s absolutely an issue.
[00:53:24] Caitlin Long: And there was someone over the weekend who brought up the DTC’s continuous net settlement system and basically said, look, all you Bitcoiners who are cheering the ETF.
[00:53:35] Caitlin Long: You guys just signed your death warrant and his explanation for that was that there will be, he predicts, a perpetual naked short in the Bitcoin ETFs, just like there are for one of the S&P500 ETFs. And the reason the DTC never closes out that position and forces the short covering is because these fault tolerances that I talked about earlier, and he explained, you can have a failure to deliver for up to 35 days, okay?
[00:54:06] Caitlin Long: And you’re just constantly rolling your failure to deliver every 35 days. and no one’s ever calling the margin call. So one of the things the SEC got right, and I’m not afraid to call balls and strikes on the SEC more than, you know, a lot of folks just think the SEC is evil. It’s not. It’s definitely not done some things right, but one thing it did do right is it said on these Bitcoin ETFs the custodian is not allowed to lend or rehypothecate in any way the underlying Bitcoin.
[00:54:36] Caitlin Long: So, assuming that that is complied with, then where are the shenanigans going to happen? At that layer 2. So the layer 2 is the ETF, and there will be derivatives and other layers piled on top of those ETFs. And that’s where the shenanigans will happen, and his point And he is right. There are these kinds of things where there are, you know, market makers are allowed to issue more ETF units than they have collateral in house just to facilitate liquid markets.
[00:55:06] Caitlin Long: Now that’s not going to be huge. That might be, you know, 5 percent of the float, but this net continuous net negative in the CNS system of the DTC that can keep rolling every 35 days. I mean, it’s, it’s caused a perpetual negative position in, in this particular ETF he was talking about. And that may happen in the, in the Bitcoin ETFs as well.
[00:55:25] Caitlin Long: I don’t think that’s a threat to Bitcoin. It’s a threat to the ETFs.
[00:55:29] Preston Pysh: Is it a threat to the ETFs or is it a threat to the market makers?
[00:55:35] Caitlin Long: Well, good question that comes back to, are some of these Wall Street firms going to blow themselves up because they don’t understand that there isn’t going to be a bailout on Bitcoin.
[00:55:48] Caitlin Long: There isn’t. And so they better not get themselves too naked short. One of the problems with the ETFs. Well, this is how prime brokerage works, is that they commingle and allow collateral substitution. So if you have a net short position and you get a margin call in that Bitcoin ETF, you’re allowed to satisfy it with cash.
[00:56:10] Caitlin Long: Okay, that’s fine, but, and this is what this guy’s point was, that means that the short position in the Bitcoin ETF is just going to keep growing. And it’s going to, it’s all, that is going to impact the price of Bitcoin. It’s not going to impact the quantity of Bitcoin. Now the hardcore Bitcoiners, when I’ve talked about this kind of phenomenon in the past, they all say, well, that just means I can buy Bitcoin more cheaply.
[00:56:32] Caitlin Long: That’s great. But it also means everybody’s pockets being picked and it also does mean that there is financial stability risk to some of the market makers. You’re right.
[00:56:42] Preston Pysh: So I think this manifests itself just for people who are listening to this now for when this probably happens. If you’re seeing a large spread between assets that are supposedly on deposit versus the price of the shares, is that kind of the canary in the coal mine that this particular ETF is in trouble with respect to similar to like what we saw with GBTC?
[00:57:05] Caitlin Long: GBTC? I was just going to say that was in retrospect a canary in the coal mine. There was also a really great thread about the Widowmaker trade. I’ll get you links to these, to these tweets because they were two people I’d never followed before. And sometimes, you know, Twitter. Twitter is filled with, you know, it’s a giant sewer sometimes, but, but it’s got just, just great nuggets of information from people who know what they’re talking about.
[00:57:26] Caitlin Long: And one guy came out and admitted he lost 700, 000 on the GBTC trade and called it the Widowmaker trade. And then he explained how he got out at a negative 38 percent return and why he’s grateful for that. And it does, Preston, it gets exactly what you’re asking about. The fact that GBTC was trading at such a huge premium was the canary in the coal mine.
[00:57:48] Caitlin Long: Something’s wrong. And a lot of people tried to arbitrage that and blew themselves up over it and we’re not done clearing it out. I think that he, this person explained that that’s a big reason why the price dropped as soon as the Bitcoin came on. Bitcoin ETFs got approved because you finally unlocked people who’d been sitting in losing positions and just wanted out of that widowmaker trade.
[00:58:09] Caitlin Long: And we’ve got to clear a big chunk of that before Bitcoin’s going to rally again. I don’t know how much.
[00:58:15] Preston Pysh: One of the things that I think is, is interesting about this is it’s not something like, let’s say your fidelity. You can’t protect against this trade happening with your paper shares as they’re being listed on all these exchanges.
[00:58:28] Preston Pysh: So it’s not something that they can even guard against. Because as people will see in some of these ETFs, if the price is, is grossly below the assets under management, that’s telling you that there’s some type of market maker that’s actually going about to blow up in this process. And so let’s walk through, let’s say that that, that scenario plays out, the market maker explodes.
[00:58:53] Preston Pysh: How does the price of the paper come back to the, the underlying assets in, or the, the, the Bitcoin that’s in the trust that represents the Bitcoin in the trust.
[00:59:03] Caitlin Long: Only at redemption, right? Okay. Yeah. Yeah. So, I mean, and ultimately this is, see, this is one of the things that, that our product team would love to do.
[00:59:14] Caitlin Long: I don’t know if the SEC will ever approve it. But an actual physical redemption from an ETF, it’s not allowed right now. Technically in ETFs, there is a physical redemption option, but it’s the issuer’s option. So one of the things we may look at down the road is having a physical redemption option at the ETF owners option, not the ETF issuers option.
[00:59:40] Caitlin Long: And this is where Custodia is in a really interesting position because as long as we execute on our business plan, and again, look at who we’ve got on our team. Wes is the tip of our iceberg. He is as committed to solvency and being one to one backed, and you can see it. You can trace your actual UTXOs, the proof of reserves that we, you know, what all of the requirements we have to comply with in, for the Wyoming laws, all that pre exam work that we had to do, all the penetration testing, the proof of reserves, that’s all codified in Wyoming law.
[01:00:16] Caitlin Long: We have to comply with it in the rules and regulations as well as the statutes. And the Supervisory Examination Handbook. That’s all out there, right? So it’s not just a best practice. It’s something we have to comply with. If we could offer that, we would.
[01:00:30] Preston Pysh: If I was one of these people pulling the strings on one of these ETFs, And I was fighting for market share or assets under management, which they’re, I mean, you talk about the Kentucky Derby, some people have called this over the next six months to nine months.
[01:00:47] Preston Pysh: I would highly encourage that you listen to the last 15 minutes of this interview and, and try to figure out how you can make that happen because. I think a massive competitive advantage for one of these ETFs is having something like that, that people inside of, that are investing their money inside of these things know that they can, they can basically pull or push the button to extract the real value out of it as Wall Streeters are going to play the games that Wall Streeters play on the paper that write on top of this.
[01:01:20] Preston Pysh: Boy, get this conversation into the hands of people that are running these ETFs. That’s my recommendation.
[01:01:27] Caitlin Long: Yeah, you know, it’s such a, there’s such a fissure in the industry because we saw You know, Vanguard went hard negative and some others are just not making these available to their customers, but several others are, so there’s like a giant divide now that the Bitcoin ETF has created within the asset management industry and within the, the wire house as the broker, broker dealers, whether they’re making this available to their customers or not.
[01:01:53] Caitlin Long: Preston, I think what you just laid out is going to, we’re going to have that divide among ETF managers down the road because You got to get the first, you know, V1 out the door, but what does V2. 0 and V3. 0 look like? Right. And this is where some of the tweaks and that’s where Custodia can play. And let me kick it over to Wes to see if he has anything to add here, because we’ve set ourselves up to be a different custodian.
[01:02:21] Caitlin Long: And to the extent that there’s an actual physical redemption someday on an underlying ETF, boy, that would be fun. And we’d love to conceptually love to participate in that. Wes.
[01:02:32] Wes Knobel: Yeah, I think the, the bailment along with our segregated account structure, this really sets us up not only for this product, but for, for anything in the future, because again, we, that transparency and that openness is really something that’s a tenant of ours.
[01:02:44] Wes Knobel: And I think that at the end of the day, that will win out over the other games that are being played in the industry. And so when you have something sound and secure, like we do.
[01:02:51] Preston Pysh: It’s only a matter of time before that rises to the top. What a checkmate move if you are a market maker that’s, that’s wanting to play these games.
[01:03:01] Preston Pysh: If the ETF has custody like this, that puts the power into the hands of the end user and, and the owner of, of the shares. I think that they would be forced to play an ethical game as opposed to the fractional reserve shenanigans that they’re accustomed to. And boy, do I hope that that’s the future. I really do, Caitlin.
[01:03:26] Caitlin Long: Yeah, and I think it will divide the ETF sponsors in the future between those that want to stick with the old fashioned games. And those that are willing to play with the Bitcoin ethos in mind that we are giving up the right to leverage ourselves and put our customers at risk. The traditional big Wall Street players probably won’t go there, but you know, among those, what it’s 11 or 12 ETF issuers.
[01:03:55] Caitlin Long: Some of those are hardcore Bitcoiners. Some of those are not at all their traditional Wall Street. I can easily see that group splitting in the coming years into one that really is committed to one to one, even if the fees are higher. It’s, you know, in a way it’s kind of like the fractional reserve banking model, right?
[01:04:14] Caitlin Long: You got to pay fees. The bank has to cover their cost of capital and their expenses. But a lot of people don’t understand that the no fee accounts, whether it’s a no fee bank account or a no fee fund through the fund management industry, there’s a lot of risk on the backside that’s not being properly priced.
[01:04:31] Caitlin Long: And that’s the punchline. And some are willing to pay higher fees for the transparency and understanding that their counterparty isn’t going to rug them the way that the traditional leveraged model potentially could end up doing.
[01:04:46] Preston Pysh: Wow. What a conversation. I learned a ton in this chat. I cannot thank you guys enough.
[01:04:53] Preston Pysh: Obviously, we’ll have links in the show notes to the Custodia Bank. Any other highlights that you guys have?
[01:04:59] Caitlin Long: Wes talk about our white paper. It’s awesome.
[01:05:02] Wes Knobel: Yeah, absolutely. So our head of products worked up a white paper and it, it really goes into our segregated account structure and the legal bailment and all of the tenants of our product offerings.
[01:05:12] Wes Knobel: So we have a get started page on our website coming over and get some more information. We can press that, we’ll get that white paper sent over to you and we’re happy to help. But anybody that’s in the, you know, institutional custody space.
[01:05:24] Preston Pysh: Love it guys. Thank you for educating and always being on the right side ethically and morally of where Bitcoin needs to move next.
[01:05:32] Preston Pysh: So just an honor to have you here, Wes and Caitlin, and thank you.
[01:05:38] Caitlin Long: Thanks, Preston, and congratulations to you on your announcement today about joining Ego Death Capital. I can’t wait to see what you guys do. That is it’s great. You know, one last thought is the Bitcoin ecosystem has continued to fund venture capital investments.
[01:05:56] Caitlin Long: It’s the non Bitcoin ecosystem that’s been in a real dearth of investments. And you guys have been able to raise. Fund two, I think he said. And that tells you something while a lot of the traditional VCs are on the sidelines, the Bitcoin VCs, these are growing. I think that speaks volumes.
[01:06:12] Caitlin Long: Congratulations.
[01:06:14] Preston Pysh: Thank you very much. I appreciate that guys. All right. Well, thanks for joining us and we’ll catch you guys next week.
[01:06:21] Preston Pysh: If you guys enjoyed this conversation, be sure to follow the show on whatever podcast application you use. Just search for, We Study Billionaires. The Bitcoin specific shows come out every Wednesday, and I’d love to have you as a regular listener. If you enjoyed the show or you learned something new or you found it valuable, if you can leave a review, we would really appreciate that. And it’s something that helps others find the interview in the search algorithm.
[01:06:50] Preston Pysh: Preston Pysh: So anything you can do to help out with a review, we would just greatly appreciate. And with that, thanks for listening and I’ll catch you again next week.
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