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digital daily: Digital Banks

Digital Banks. Digital banking will unlock mainstream financial services to the digital ecosystem. It will bridge old and new finance. But what is a digital bank? It is a question the Federal Reserve Board proposed indirectly last May for public feedback (here). It was an exercise of determining what would define a ‘novel banking institution’ gaining access to Fed financial services. On March 1, the Fed updated its proposal to include a three-tiered review process with federally insured institutions to receive the most streamlined evaluation (here). Between the President Executive Order, the President Working Group stablecoin evaluation, Treasury Secretary Yellen’s interview warming to digital innovation, and various legislative movements, there is clearly a policy pivot to bring the digital into the mainstream. Quietly in the background, digital is accelerating its entry into the orbit of mainstream banking. Custodia bank, and now Kraken Financial last week, received ABA routing numbers. These are the same numbers that are used to identify a Master Account at the Fed that would allow digital banks to operate seamlessly between digital and fiat currencies. The lines between digital and fiat will be blurred thereafter – decentralized digital becomes a permanent part of financial infrastructure. The initial ambition of digital banks is modest. Custodia and Kraken operate as Special Purpose Depository Institutions under Wyoming State law. Fiat deposits must be 100% reserved, a protective shield to conventional banks. Yet, conventional bankers rallied forcefully against the leap to digital. Lobbyists went so far to argue that Kraken would lose money and cause a run dynamic by taking duration risk with deposits (“Beware the Kraken,” here). So, what will digital banks do with access to Fed services? Provide seamless fiat-digital transactions and start with basic services – money transfer, bank asset custody, and stablecoin backed by deposits at the Fed. Conventional banks embarked upon this journey in 2014 with a closed system (here). Who is participating? Proponents of a closed system, the ones warning about the Kraken, building deeper moats. The wait is almost over. Digital disruption is only just starting.