How rising interest rates drove this crypto stock higher

This has been a year many investors would like to forget, too S&P 500 index its worst start to the first half of the year in 50 years. The cryptocurrency markets have taken an even bigger hit, and Bitcoin is down over 50% since the beginning of the year.

The volatility in the crypto markets has hurt many stocks, including the crypto bank Silvergate capital (SAY -7.53%). However, the bank surprised some investors when it announced stellar earnings results this week. Despite volatility in the crypto markets, the bank smashed estimates, thanks to rising interest rates. This is how.

Interest rates are rising at the fastest pace in many years

In June, the consumer price index (CPI), which measures changes in the cost of consumer goods, rose 9.1% year-on-year. This is the highest reading we have seen since November 1981.

In response, the Federal Reserve raises interest rates to slow the economy and curb consumer spending. It hopes this will bring down inflation. Since March, the Fed has raised interest rates from near zero to a target range between 1.5% and 1.75%.

Effective Federal Funds Rate data from YCharts.

Rising interest rates have a ripple effect throughout the economy. Banking is among the industries that benefit when interest rates rise.

Specifically, the banks collect interest on loans and pay interest on deposits, and the difference between these two is called net interest income. This tends to rise when interest rates rise because the banks can take in more interest income than they pay out on deposits. This is where Silvergate has a big advantage.

Silvergate’s deposit advantage over its peers

Silvergate provides banking services with a focus on cryptocurrency customers. One of its main products is the Silvergate Exchange Network (SEN), which enables cryptocurrency exchanges to transfer US dollars between each other. SEN has helped Silvergate significantly increase its non-interest-bearing deposits, giving it an advantage over traditional banks. Over 99.5% of Silvergate’s $13.5 billion in deposits are non-interest bearing.

The bank places this money in a conservative portfolio of cash and other short-term securities with attractive risk-adjusted returns. The advantage of Silvergate is that when interest rates rise, the interest income from loans increases, while the interest paid on deposits remains minimal.

Image source: Getty Images.

Conspicuous growth in net interest income

Silvergate Capital brought in over $38 million in net income in the second quarter, representing growth of 41% from the first quarter and 84% from the same quarter last year. This increase was primarily due to net interest income, which was $70 million in the quarter, up 33% from the first quarter and 132% from the same quarter last year.

Silvergate benefited from rising interest rates, which boosted returns on its interest-earning assets. The bank aims to keep high-quality loans on the books, and 97% of the securities are rated AA or better. Furthermore, 55% of the securities have floating interest, so when interest rates rise, interest income will increase at the same time.

Image source: Silvergate Capital.

What to expect

Silvergate Capital is a well-run bank that got into the cryptocurrency game early, giving it a big first-mover advantage. The move to crypto has given the bank a significant leg up over its peers in terms of non-interest-earning deposits, which became evident this year when the Fed aggressively raised interest rates.

According to the company, an interest rate increase of 25 basis points will increase net interest income by 16 million dollars over one year. Experts expect the Fed to raise interest rates another 75 basis points at its July meeting later this month, which would translate into an additional $48 million in interest income for Silvergate over the next year.

Silvergate could also have benefits if the Fed were to pivot and go back to cutting interest rates. That’s because cryptocurrency prices — which correlate with tech stocks — can rise in line with crypto trading volume, which takes advantage of Silvergate’s network products and puts it in an excellent position to profit, regardless of what the Fed does.