Crypto industry may escape lasting damage from Silvergate liquidation

Banks are the lifeblood of a nation’s economic system, and any bank collapse is troubling. Last week there were two errors. On March 8, Silvergate Capital – the cryptocurrency-focused banking company – went into voluntary liquidation. On March 10, US regulators shut down and seized the deposits of technology-oriented Silicon Valley Bank in what was called the second largest bank failure in US history. Both institutions in California were victims of bank deposits.

The fallout from the collapse of Silicon Valley Bank (SVB) could be significant, although it is too early to tell. Stablecoins like USD Coin (USDC) and Dai (DAI) losing their dollar pegs is never a good sign, but they were recovering by Sunday, March 12. However, the Silvergate Bank debacle is unlikely to cause long-term damage to the crypto sector.

The fall of the San Diego-based Federal Reserve member bank should be a minor event compared to the earthquake triggered by FTX’s bankruptcy in November 2022, sources told Cointelegraph. FTX’s implosion hurt many crypto firms, including Silvergate Bank. In comparison, the fallout from the bank’s liquidation should be more limited. It may even provide some valuable lessons about diversification – a fundamental principle of risk management that seems to be forgotten when markets rise.

There will likely be short-term consequences that will likely make life more difficult and expensive for crypto firms to find banking services in the US. And it is not just the United States that is experiencing some unrest.

In Latin America, which is primarily a cryptocurrency (FX) market where many firms buy stablecoins like USDC and Tether (USDT) as a means of sending funds abroad, “the Silvergate fallout was problematic,” Thiago César, CEO director of fiat. on-ramp provider Transfero Group, told Cointelegraph.

“Most crypto exchanges lost their US dollar rails.[…] It affected the crypto-driven alternative currency market in LATAM.” Local Brazilian dealers in USDT and USDC were suddenly unable to replenish their inventory, César reported. (This interview was conducted before the SVB seizure, which further rattled some stablecoin firms.)

Josh Olszewicz, head of research at Valkyrie Digital Asset Management, told Cointelegraph: “The lack of off-ramps as well as general banking needs of consumers and businesses interacting with the crypto industry could be hampered in the short term.” Coinbase, Paxos, Gemini, Bitstamp and Galaxy Digital, among others, used Silvergate as a banking partner.

That said, the Silvergate collapse is unlikely to pose long-term obstacles. “Basically, a bank exiting the crypto industry does not harm any blockchain, including Bitcoin,” Olszewicz added.

Lesson?

Joseph Silvia, partner at law firm Dickinson Wright – and former advisor to the Federal Reserve Bank of Chicago – sees Silvergate Bank’s liquidation more as a “cautionary tale” than a harbinger of tougher times ahead for the crypto sector. The bank was insufficiently diversified and dependent on the crypto industry for its deposits. Similarly, Silicon Valley Bank was arguably too concentrated on technology-based venture capital firms. In both cases, a trickle of customer deposits quickly turned into a torrent.

More than 90% of Silvergate’s deposits were from crypto-related firms, and after FTX’s implosion in November, jittery investors withdrew those deposits in what amounted to a classic bank run. This activity did not go unnoticed by US banking regulators. The Federal Reserve and the Office of the Comptroller of the Currency issued a joint statement in February, warning banking organizations of “liquidity risk” as a result of “vulnerabilities in the crypto-asset market.”

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In the wake of Silvergate’s liquidation, some traditional banks may now close their doors entirely to crypto accounts, while others may severely limit the acceptance of crypto deposits, Silvia said. This is likely to increase costs for US crypto firms as their banking options become more limited.

Apart from being too concentrated on a single high-risk industry sector, Silvergate may have invested in the wrong assets. As Austin Campbell, an adjunct professor at Columbia Business School and managing partner of Zero Knowledge Consulting, told Cointelegraph: “Essentially, you want to either have a very diversified deposit base if you have longer-dated assets because you can’t easily survive a run and need the diversification, or if you are highly concentrated, you should have a much shorter duration of assets so that you can easily liquidate in the event of mass withdrawals.” Campbell added:

“Silvergate was highly concentrated and held securities with longer durations. You can’t do both. You must choose one. It would be fine to be so concentrated if they didn’t extend the duration on the asset side.”

Campbell doesn’t think Silvergate’s collapse will be as significant to the crypto sector as FTX’s collapse – nor will it have much of an impact on the wider banking industry. Silvergate’s assets totaled $11.4 billion at the end of 2022, which is mid-sized by US banking standards.

By comparison, JPMorgan Chase’s balance sheet at the end of the year was $3.66 trillion, more than 300 times larger. SVB, with $209 billion in assets, is somewhere in between. Silvergate is “the definition of a small problem” from a mainstream banking perspective, observed Campbell, who went on to say:

“For crypto, FTX was a huge problem, not only because of the volume, but because of the staggering depth of the fraud and mismanagement. It seems that Silvergate has just messed up asset-to-passivity, which is an age-old problem in banking. It wasn’t that the CEO stole billions from customers.”

“FTX was a much more serious problem,” said Justin d’Anethan, director of institutional sales at Amber Group – a Singapore-based digital asset firm. D’Anethan added, “Countless entities were funded, traded, held, earned returns and lent to either the FTX exchange or the Alameda fund. It rippled into the entire crypto space.”

Silvergate may have an impact in the US, “but that still leaves crypto behind [firms] with many alternatives and substitutes, and, if anything, the drive to become more decentralized,” d’Anethan continued. In the short term, “other crypto-friendly banks such as BCB, Prime Trust, SEBA” offer on-ramp/off-ramp and FX conversions. “Obviously, for mainstream or institutional adoption, you need fiat rails for fresh capital to come into crypto markets. But at this point, there’s nothing that makes me think we’re going to be short of them.”

Others suggested that US regulators are bent on scaring traditional banks from doing business with cryptocurrency exchanges. Will it result in crypto firms moving out of the US, with users moving to peer-to-peer transactions like in China, as Samson Mow recently suggested?

“I think many US-based businesses will already have or are in the process of finding overseas solutions. And this will benefit jurisdictions that are more crypto-friendly. I’m thinking Dubai, Singapore, Hong Kong, maybe the UK or Switzerland,” said d’Anethan, adding:

“For retail, if based in the US, it will be more difficult. Ironically, in an effort to protect retail investors, regulators may prevent them from being exposed to an industry that – if history is any guide – continues to grow and gain worldwide adoption.”

Valkyrie’s Olszewicz even saw a positive outcome if the US finally got sensible crypto regulation. “Potentially, as digital asset businesses and exchanges become increasingly regulated, the larger traditional banks may warm to establishing relationships with those in the digital asset space. If not, yes, more and more businesses and capital will move offshore as crypto does not coming somewhere soon.”

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“I think the long-term effect will be that banking relationships move elsewhere, and in a positive case they become both more diversified and more robust,” said Campbell of Columbia Business School. “However, the US regulators are moving in the other direction and taking this as an example of crypto being the problem – it’s not, poor risk management was – so this could also force crypto to build stronger banking relationships both in Asia and in Europe , especially in a post-MiCA [Market in Crypto-Assets] world.”

Just growing pains?

More regulatory clarity on cryptocurrencies and blockchain technology would be helpful, suggested Dickinson Wright’s Silvia. At some point, US regulators may become more explicit in their advisory statements – for example, banks warn that if they accept crypto deposits, the total value cannot exceed 5% of the total liability. Meanwhile, crypto deposits remain a liquidity risk, Silvia added. “They are not as sticky as traditional deposits.”

Some US crypto firms may need to find new banks, while traditional banks may be more hesitant to accept crypto-related deposits – at least for now. But the nascent crypto industry is going nowhere, added Silvia, who sees the current turmoil as growing pains. A little weeding out of bad actors is probably necessary at this stage. That said, the crypto sector remains “an interesting value proposition,” he told Cointelegraph.