How the crypto industry is reacting to recent bank bailouts

In its early days, crypto enthusiasm was fueled by the promise of cutting the rigged banking system out of the people’s basic need to exchange goods and funds. To some extent, it still is. But as digital assets become more and more intertwined with a larger financial market, this tension is gradually disappearing.

The recent spate of partial bailouts from failed institutions such as Silvergate Bank, Signature Bank and Silicon Valley Bank (SVB) has not caused any concerns among the crypto community. Also, the United States Federal Reserve System came to the rescue, at least with regard to USD Coin (USDC) issuer Circle, which held a significant portion of its reserves in Signature Bank and SVB.

If the Fed decided to let the banks fall, we would probably have witnessed another sharp fall in the crypto market and not the optimistic resurgence of the past two weeks.

Does this mean that the crypto industry has reached a point where it is highly dependent on traditional banking and can no longer resist as an alternative? Is that kind of interconnection desirable for digital assets, or should the industry create some distance from traditional finance (TradFi)?

Was it a rescue operation?

Technically, both SVB and Signature were bailed out, but economists highlight the stark difference between today’s solution and the US government’s actions during the 2008 financial crisis.

“During [2008] financial crisis, it was investors and owners of systemic big banks who were bailed out,” as Treasury Secretary Janet Yellen explained, but this time it was depositors who got their backs covered by the deposit insurance fund, provided by the banks, not taxpayers. .

The Federal Deposit Insurance Corporation (FDIC) has effectively guaranteed all deposits at both banks above the normal limit of $250,000 per account. Yet it was only because of the FDIC’s support that Circle was able to withdraw the entire $3.3 billion deposit from SVB and save USDC from further depegging.

Recent: US law enforcement agencies turn up the heat on crypto-related crime

Still, isn’t there something strange about an industry with a strong anti-establishment and even anti-Fed background that takes federal support for granted, if not outright advocates for it?

Perhaps not, as no speaker Cointelegraph has stretched to see any ethical contradictions here. There is an overlap between the crypto community and the startup community, so naturally there has been a lot of support for the bank bailouts, explained Daniel Chong, CEO and co-founder of Harpie:

“I personally don’t see a dissonance here: You can be a TradFi skeptic and still be in favor of startups having a way to continue operations and make a salary. We don’t need thousands of employees without wages to prove that DeFi is a viable economic system.”

Although the DNA of the crypto community would oppose a bailout, Tony Petrov, head of legal at risk management platform Sumsub, told Cointelegraph that sometimes it is very important to at least try to save valuable institutions on the border of crypto and fiat – especially given the obvious lack of such institutions.

Of course, bailouts have taken on a negative connotation not only within the crypto community. In some cases, a bailout looks like billionaire executives getting taxpayer-funded handouts in exchange for their own bad decisions. The philosophy of “too big to fail” helps completely inefficient and poorly managed banks to stay where they are, even if they provide no real value to the society in which they exist. But, Petrov continued, it is hard to deny that what happened to SVB, Silvergate and Signature was not a clear example of mismanagement solely on the part of the banks’ executives:

“After all, they invested in government notes, not in some shady digital coins, the value of which can hardly be predicted even within a day. Taking this topic very low, it can be argued that part of the blame for the consequences should be borne by the American the government.”

Is crypto really to blame?

Although panic among crypto investors following the FTX debacle played a role in draining the bank’s crypto deposits, Signature’s problems were much more deep-rooted, Ahmed Ismail, CEO of liquidity aggregator Fluid, told Cointelegraph.

The bank served a tight-knit set of clients, including a group of startups and their investors. Ismail said it aimed for rapid growth without sufficiently diversifying its business or clientele:

“Truth be told, companies dealing with such tightly knit customer circles always face the risk of experiencing a domino effect.”

Petrov also does not buy into the hypothesis that crypto is to blame for the banks’ collapse. In a conversation with Cointelegraph, he highlighted the common problem of Silvergate and SVB, which ironically was their faith in US Treasuries. By raising interest rates, the Federal Reserve naturally dropped their value, and the simultaneous unrest in SVB provoked a bank run.

Some argue that it is the crypto industry itself whose financial stability is being undermined by interconnection with the banking system: more specifically, by the extreme limitations of this connection. The crypto market has been backed into a corner of the traditional banking system, Chong argued.

Even before the collapse of Signature, SVB, and Silvergate, there were only a handful of entities willing to bankroll crypto companies. It is impossible for a crypto company to diversify its assets across many different institutions since there are not 20 banks that want it:

“The idea that ‘crypto is too risky to bank’ has become a self-fulfilling prophecy. The few institutions willing to bank with crypto companies face very high demand from a market that has nowhere else to go. They become “crypto banks” by default, and all the risks inherent in these fast-moving markets end up in a few institutions.”

What should be done?

What can the crypto industry do to escape the sudden dangers of relying on banks? Not much. The paradox is obvious: cryptocurrencies won’t need banks if they somehow become the main means of exchange and accumulation, but the only way for them to get to this utopian point is through their exchangeability with fiat money. To Petrov, building a fence against TradFi because of this demand for interchangeability seems like a counterintuitive idea.

An independent world of crypto is still a great libertarian promise, but nothing more, he explained, “In the background of the collapse of three huge crypto-friendly banks, we saw the increase of BTC for more than $8,000 in 10 days. This is proof that there is no distance between fiat and crypto: They communicate like the venous circuit and arterial circuit in a human organism.”

Oliver Chapman, CEO of supply chain specialists OCI, also doesn’t see how crypto can escape TradFi. All in all, TradFi has stepped in to support a bank that was essential to the crypto industry,” he told Cointelegraph.

The crypto industry may or may not distance itself from TradFi, but if it does, it will either be small and unimportant or pose a systemic risk, Chapman said, stating: “Finance is either important or we go back to the caves. And either that funding is traditional, crypto or a combination, when things go wrong, a systemic crisis that could trigger a catastrophic global recession remains a danger.”

Recent: How Montana can benefit as its pro-crypto mining bill gets approved

The crypto-economy can continue to improve its performance without coming into direct conflict with banks and similar traditional financial institutions, Ismail stated. It has already made finance more accessible and cost-optimized by cutting out cost-bearing intermediaries. In addition, the use of cryptography and smart contracts in decentralized finance has improved the system’s security without compromising efficiency. But there is nothing inevitable about the conflict between the two systems, Ismail said:

“I don’t see why traditional finance and crypto-economy should be pitted against each other. Both can coexist without the cost of the other.”

Chong does not take this conviction for granted. In his opinion, we are going to see a lot of value move up the chain precisely as a result of such collapses within the traditional financial system. The question is whether the crypto market, with its own wave of devastating collapses in 2022, is ready to serve as a safe alternative to banks. To be the alternative to TradFi, the crypto community needs to come up with some standards on how to manage corporate assets.

Chong added, “In the current environment, you have to be a crypto-native engineer to have any chance of keeping your blockchain assets secure. It’s not scalable.”