Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insight on policy and regulation.
Custodia is on a one-bank crusade after the Federal Reserve denied the Wyoming crypto firm’s application for Fed membership in late January, plowing forward with a lawsuit challenging the decision. After filing an amended complaint decrying the Fed’s actions, Caitlin Long, Custodia’s founder, wrote a post arguing for a regulated crypto bank while the broader industry is under fire. “Custodia has been denied and now disparaged for daring to come through the front door,” she proclaimed.
Left unsaid was the fact that the Fed let a bad actor in through the backdoor: Sam Bankman-Fried's FTX. Now, with banking regulation the topic du jour in crypto circles, the question remains: What happened with Moonstone Bank?
A brief refresher: Moonstone, née Farmington State Bank, was the 26th-smallest bank in the country until Jean Chalopin, the chair of the notorious Bahamian crypto bank Deltec, got involved. In 2020, his company FBH acquired the tiny bank, ultimately gaining approval in June 2021 to come under the Fed's regulatory umbrella, and soon thereafter rebranding as the digital assets-focused Moonstone Bank.
In March 2022, FBH announced it had raised $11.5 million from Bankman-Fried's hedge fund, Alameda Research, to expand Moonstone. Fed filings show that the value of its common stock soared from $1.35 million to $13.4 million with the investment. Alameda, by that calculation, owned well over 80% of the total equity.
Recall Moonstone was now a Fed-regulated bank. The agency, of course, has strict guidelines for what types of companies can take a controlling stake in the holding companies for Fed-regulated banks. A review of the rules reveals that Alameda’s purchase should have tripped the alarms of presumed control.
Following FTX’s collapse, Moonstone sought to distance itself from the Alameda purchase, clarifying in a November 2022 press release that Alameda had a “non-controlling minority common-share interest” in FBH, or under 10%. Janvier Chalopin told Protos that the seemingly small figure was because of a new, gargantuan $115 million valuation for the bank, which still doesn’t necessarily make sense given its own accounting.
I called up FBH to try to settle the matter. The listed contact no longer worked there, but the kindly receptionist put me in touch with Josey Booth, the director of business operations for Farmington/Moonstone (Booth is named after the Clint Eastwood movie The Outlaw Josey Wales, the receptionist explained, lamenting my young age).
Booth couldn’t clear up the mystery, although he told me the initial $1.35 million filing seemed off, and that the increased valuation was due to Moonstone’s pivot to a digital banking platform, which still doesn’t quite explain how Alameda owned less than 10%. A spokesperson from the Fed declined to comment.
A former Fed official, who spoke on the condition of anonymity, told me that even if Moonstone had slipped between the cracks, it was likely because as a tiny bank, it only had to file paperwork twice a year. If the system had worked correctly—if Moonstone, as a Fed-regulated bank, had to share that Alameda had taken a controlling stake, and if the Fed had carried out its prudential oversight duties and dug into Bankman-Fried's empire—then the FTX catastrophe might have been prevented or at least blunted.
That, as Long would argue, is coming in through the front door.
“You can’t just make up an Excel spreadsheet with a bank,” said Jess Cheng, a partner at Wilson Sonsini and former senior counsel at the Fed. “That’s what it means to bring [crypto] into the regulatory perimeter.”
Leo Schwartz
leo.schwartz@fortune.com
@leomschwartz
