On May 25, 2021, Governor Ricketts signed the Nebraska Financial Innovation Act (“NFIA” or the “Act”) into law, making Nebraska the second state, following Wyoming, to establish digital asset depositories.1 NFIA authorizes the formation of digital asset depositories, either as a separate department of an existing financial institution or as a newly chartered digital asset bank, upon approval from the Nebraska Department of Banking and Finance (the “Department”).2 Once approved, a digital asset depository can engage in certain services relating to digital assets (e.g., cryptocurrency).
What Services Can a Digital Asset Depository Provide?
Under NFIA, a digital asset depository can provide custody services for cryptocurrency (such as Bitcoin). Although not specifically addressed in NFIA, cryptocurrency custody services presumably mean a depository may hold the unique cryptographic keys associated with a customer’s virtual currency. Cryptographic keys are strings of data that lock or unlock encrypted digital asset data. Cryptocurrency owners have a public key that allows them to accept payments from other cryptocurrency users and a private key to prove ownership of the specific digital currency.
Apart from providing custodial services, digital asset depositories may also:
- Provide payment services upon a customer’s request;
- Conduct non-lending digital asset banking business for customers, including facilitating the provision of borrowing or lending in which digital assets are borrowed, paid, or pledged to a lender in exchange for digital assets;
- Issue stablecoin (cryptocurrency backed by a reserve asset such as being tied to the U.S. dollar) and hold stablecoin deposits at an FDIC-insured financial institution which has a main chartered office or branch in Nebraska; and
- Use stablecoin and independent node verification networks for payment activities.
NFIA also authorizes a financial institution to serve as a qualified custodian for a registered investment adviser subject to applicable SEC rules and additional rules and regulations adopted by the Department.
Cryptographic keys are strings of data that lock or unlock encrypted digital asset data.
How is a Digital Asset Depository created?
NFIA establishes two ways to create a digital asset depository. Financial institutions3 may apply for authority to operate a depository as a separate department within the financial institution. Although NFIA does not define what is required to maintain a “separate department,” it requires an amendment to an institution’s articles of incorporation to authorize the conduct of a digital asset depository business. Alternatively, five or more adult persons (including at least one Nebraska resident) may form a digital asset depository by applying to the Department to obtain a new charter.
NFIA provides that a financial institution may invest up to 10% of its capital and surplus in a digital asset depository institution unless written approval to invest a higher percentage is obtained from the Department. The Act further provides that bank holding companies may apply to maintain a digital asset depository, subject to federal and state law.
An application by a financial institution to form a department as a digital asset depository business or an application by individuals to create a newly chartered digital asset depository institution requires, in each case, the following:
- A detailed business plan;
- Estimated operating expenses for the first three years (with applicants seeking a new charter required to pay a surplus fund in such amount or other amount established by the Department);
- A proposal for compliance with NFIA requirements; and
- Payment of a $50,000 application fee.
Applicants seeking a new charter must submit articles of incorporation, evidence of a minimum of $10 million capital stock (which must be solicited before the filing of an application and returned without loss if an application is denied), and identification of any investors holding 10% or more of the proposed institution’s equity.
After a complete application has been filed, the Department will investigate the background of officers, directors and shareholders owning 10% or more of the applicant’s equity. A public hearing on the application will be held within 60 to 120 days after notice from the Department that the application is in order.4 Within 90 days after receiving a public hearing transcript, the Department will decide on the application based on criteria outlined in NFIA.
What Compliance Requirements Must Digital Asset Depositories Satisfy?
NFIA includes several compliance requirements for digital asset depositories. Among other things, a digital asset depository must:
- Maintain its main office and the primary office of its CEO in Nebraska;
- Help meet the digital financing needs of communities in which it operates, and maintain and update a public file and its website(s) with information about its efforts to meet community needs;
- Maintain unencumbered liquid assets of at least 100% of the digital assets in custody at all times;
- Submit reports regarding the depository’s condition (such reports shall be made publicly available, with the Department having the ability to impose a fee of $5,000 for each day a report is overdue);
- Be subject to examination to determine the depository’s condition and resources, mode of managing the depository’s affairs, actions of its officers and directors in the investment and disposition of funds, the safety and prudence of digital asset depository management, compliance with NFIA and other matters as the Department may require;
- Furnish a surety bond or pledge assets in an amount determined by the Department to be sufficient to cover the costs of liquidation or conservatorship;
- Maintain appropriate insurance or a bond covering operational risks of the digital asset depository, which must include coverage for directors’ and officers’ liability, errors and omissions liability, and information technology infrastructure and activities liability; and
- Pay an assessment (as determined by the Department and approved by the Governor) which shall offset costs of supervision and administration of the Act.
In addition, digital asset depositories must adhere to several customer-facing requirements, including:
- The customer must provide sufficient evidence to the depository that it will comply with the anti-money laundering, customer identification and beneficial ownership requirements under the Bank Secrecy Act and policies and procedures of the depository;
- If the customer is a legal entity, then it must provide reasonable evidence that it conducts a lawful, bona fide business;
- The terms and conditions of a customer’s digital asset depository account must include a list of mandated disclosures, such as a schedule of fees and the manner and timing of their calculation, statements that digital asset depository accounts are not FDIC insured and that an investment in digital assets is volatile and may result in total loss of value and other statements outlined in NFIA relating to risks associated with digital assets; and
- All advertising, marketing materials and websites must also include conspicuous notices that digital asset deposits and accounts are not FDIC-insured, as well as the text of a statutory notice outlined in NFIA regarding the substantial risk and speculative nature of holding digital assets.
NFIA also includes additional restrictions that apply uniquely to newly chartered digital asset depository institutions (as opposed to departments established within existing financial institutions), including:
- Requiring “digital asset bank” to be used in the institution’s name so that it does not resemble the name of any other financial institution transacting business in Nebraska;
- Prohibiting acceptance of U.S. currency demand deposits or U.S. currency that may be withdrawn by check or similar means; and
- Prohibiting consumer, commercial, or mortgage loans of any fiat currency, including temporary credit relating to overdrafts.
If a financial institution serves as a qualified custodian for a registered investment adviser, NFIA sets forth additional restrictions to those services.
What’s Next?
NFIA authorizes the Department to adopt rules and regulations necessary to implement the Act, providing further guidance regarding the Act’s provisions. Federal bank regulators are also expected to issue guidance concerning digital assets. The law will continue to evolve in this area.
Banks, bank executives and bank owners interested in the potential expansion of banking services to digital assets services or the entrance into such area by non-bank owners should continue to monitor these legal developments and best practices that may apply to digital asset services covered by NFIA.
1 On June 10, 2021 the Texas Department of Banking issued a notice affirming that Texas state-chartered banks may provide customers with virtual currency custody services, provided the bank has adequate protocols in place to effectively manage the risks and comply with applicable law.
2 NFIA also adds a new section to the Nebraska Uniform Commercial Code relating to controllable electronic records, including security interests in digital assets. NFIA’s provisions relating to the creation and operation of digital asset depositories become effective October 1, 2021. The remainder of the Act (including the UCC provisions which are not discussed in this articles) is effective July 1, 2022.
3 “Financial institutions” under NFIA include national or state chartered banks, S&Ls, savings banks, building and loan associations and trust companies; credit unions are not included.
4 The Department shall electronically send notice of the hearing to financial institutions in Nebraska, federal agencies and financial industry trade groups.
Gray Derrick is a partner at Baird Holm LLP and chair of the Firm’s Technology and Intellectual Property Section. He focuses his practice on developing, acquiring, and using technology and other forms of intellectual property.
J. Scott Searl is a partner at Baird Holm LLP and the Firm’s Financial Services Industry Team leader. Scott represents banks, bank holding companies and their owners on mergers and acquisitions, corporate governance and regulatory matters.
Carrie Schwab and Greg Dittman, summer associates of the Firm, contributed to this article.
