Crypto Takeaways from Recent Bank Failures

Not all bank failures are caused by crypto, and the recent one is no exception.

After the rapid collapse of Silvergate Bank, Silicon Valley Bank and Signature Bank, including the 2nd and 3rd largest bank failures in US history, finger pointing and blame games were inevitable and crypto was unfortunately held up as a convenient scapegoat for these failures. The reality is far more nuanced, and although the findings are still being made public (including questions about share sales by some executives), it does not appear that crypto is the primary cause of this financial instability. Crypto may have been associated with these financial institutions, and a bear market is undeniably underway, but there were several other factors that combined to contribute to the current instability and uncertainty in the financial sector.

First, external economic factors (as always) affected the health and stability of these financial institutions, including the rapid rate hike by the Federal Reserve, persistently sticky inflation, and a slowdown in the fintech, startup, and crypto communities. Second, and particularly at Silicon Valley Bank, the decision to invest heavily in long-duration instruments that locked in extremely low rates of return led to large unrealized losses. These unrealized losses were quickly realized when – to meet a flood of customer withdrawal requests – this security portfolio had to be wound down quickly.

An additional factor unique to these recent bank runs and failures is the speed with which these events occurred. Previous bank runs could take months to play out, while these three (3) financial institutions were shut down within days. If crypto is to truly become the future of money, and take a leadership position as a medium of exchange, advocates, developers and investors need to heed the lessons that can be learned from this experience.

Risk management is essential. Time and time again, as these banks collapsed, in addition to placing the blame on the crypto sector, it became clear that risk management was questionable in at least some cases. Silvergate, by its very nature, had been heavily exposed to the crypto sector (with FTX as a major client) during the last bull market, Silicon Valley Bank bet heavily on low-yield instruments that lost value quickly, and Signature Bank had been the target of several investigations earlier; Entering the crypto market only reinforced this scrutiny.

Crypto organizations have received a powerful wake-up call over the past year or so, particularly as US regulators have cracked down on the sector at large. Putting aside some opinions that this is a targeted campaign to crush the US crypto space, the bottom line from these recent events is that risk management must be a priority for financial institutions, fiat or crypto-based. Moving fast and breaking things can be a great ethos for tech companies, but for financial players, more caution would be wise.

Liquidity is important. As financial institutions, both crypto and fiat, have experienced in an era of rapid interest rate increases, such a rapid change in the interest rate environment can have a dramatic effect on financial viability. Handling redemptions and withdrawal requests is part of the fundamentals that any firm looking to take deposits and make loans must 1) fully understand and 2) actively manage. Ultimately, and based on the evidence and comments that have been made public to date, the failure of at least SVBVB and Signature was largely driven by the pace of withdrawal requests and management’s inability to comply with said requests without destabilizing the institutions.

Stablecoin issuers, including Circle, which was revealed to have over $3 billion in deposits with SVB, should take note of these events, as well as the implications it will have on this market going forward. Already under scrutiny and investigation on multiple fronts, stablecoin issuers have quickly gone from being perceived as a quieter version of crypto to one that has attracted regulators. Combined with the recent regulatory announcements warning and cautioning financial institutions about the risks of servicing crypto organizations – including stablecoin issuers – liquidity needs to be monitored more than ever.

Redundancy plans. As should hopefully be self-evident at this point, especially given the speed with which banking institutions collapsed in a single weekend, both investors and institutions need to have contingency plans in place to deal with such market volatility. This idea can take many different forms depending on the institution in question, but should include 1) access to sources of liquidity, 2) ways to communicate plans and updates to investors, and 3) a real-time financial reporting protocol to both inform and potentially reassure investors and regulators.

Crypto firms would be wise to follow many of the same recommendations, especially for crypto firms looking to issue coins and/or tokens to be used as a medium of exchange. Currency, and financial companies more generally, rely on the trust and confidence placed in them by users and depositors, and stablecoin issuers – already on the hot seat from a regulatory perspective – should take particular note. Establishing contingency plans, and communicating these plans to the market – especially in periods of uncertainty – should be prioritized going forward.

Economic conditions continue to be fluid, and crypto has an opportunity to learn from the mistakes of others to build stronger and more resilient applications as a result.

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