Silicon Valley Bank’s downfall has many causes, but crypto is not one

by · March 20, 2023

Silicon Valley Bank (SVB) boasted over $200 billion in assets and was a lifeline for crypto companies.

Notably, it was one of the few institutions offering services to crypto companies in the US, as other banks shied away from the sector, fearing risk and the possibility of a sudden regulatory crackdown.

The collapse of SVB, Signature Bank and Silvergate Bank, all within a short period of time, has raised fears of another financial crisis in 2008. As politicians continue to assure the public that they are working on a recovery plan – with the Biden administration announcing measures to protect depositors – the bank run created panic in US markets.

A bank run occurs when the majority of depositors in a particular bank decide to withdraw their money at the same time. Most banks do not keep all depositors’ money on hand since – under the fractional reserve banking system – banks are only required to hold a percentage of customer deposits at any given time.

The system has been successful for a long time, but every decade or so there is a bank run that exposes the vulnerability of the banking system.

These banks experienced asset-liability mismatches due to higher deposits than credit during the COVID-19 pandemic. This led to the banks’ overuse of liquidity in bonds in the public and private sectors. But with rapid interest rate hikes by the US Federal Reserve, these banks incurred huge losses, which eventually led to a liquidity crisis.

The mismatch between assets and liabilities, although common in most situations for banks, was unsustainable in the current scenario due to the sharp decline in deposits.

Crypto gets entangled in the US banking crisis

The crypto industry has faced a lot of criticism recently due to a series of high-profile collapses and losses for investors. In the case of SVB, however, crypto’s involvement was less causal and more due to counterparty risk from stablecoin issuer Circle.

Following SVB’s fall on March 10, USD Coin (USDC) issuer Circle announced that nearly $3.3 billion of the reserves backing USDC were tied up in SVB.

The announcement drastically affected the stablecoin, which lost its peg to the US dollar, eventually falling to $0.87. The depegging of USDC created panic in the crypto industry as the stablecoin has the second largest market share, and is popular among centralized and decentralized ecosystems.

Although Circle assured that it would compensate for the shortage with other assets, traders and whales began to exchange USDC for other stablecoins available in the market – even at a loss.

A panicked trader who attempted a risky and ultimately costly move to exit USDC received only $0.05 in Tether (USDT) for $2 million worth of USDC.

In contrast, those who remained confident that the USDC would eventually regain its peg began buying USDC at a lower value in hopes of making a profit when the price rose back to $1.00.

USDC finally reverted to the US dollar on March 13, as Circle confirmed it had found a way to move its funds out of SVB. The banking crisis-induced panic in the crypto markets subsided within days.

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Indeed, crypto reversed the narrative and proved to be a safe haven during the ongoing banking crisis, even when most traditional markets and financial institutions were bleeding red. While they fell slightly on March 10, the prices of major cryptocurrencies such as Bitcoin (BTC) and Ether (ETH) have seen a marked improvement over the past 10 days.

SVB Financial Group, the parent company of SVB bank, finally filed for bankruptcy on March 17 in the US Bankruptcy Court for the Southern District of New York.

US regulators are getting in on the action, but is it too little too late?

While crypto as an asset class may have emerged from this crisis relatively unscathed (at least for now), questions remain about the root causes of the crisis and whether it could have been avoided.

Cathie Wood, CEO of asset management firm ARK Invest, criticized regulators and the Federal Reserve for failing to stop the current bank run, saying enforcement agencies were using cryptocurrency as a scapegoat for their banking oversight failures.

Despite these criticisms, the Fed is investigating the circumstances surrounding the Silicon Valley Bank’s fall, with Fed Deputy Chairman for Supervision Michael Barr recently launching a review of the situation. The report’s findings are expected by May 1.

The US Justice Department and the Securities and Exchange Commission have also launched independent investigations into the SVB collapse, including reports of sales of the bank’s stock by executives just days before regulators shut it down.

However, the SVB bank run is not a new phenomenon. Tony Petrov, a blockchain and fintech lawyer, told Cointelegraph that the banking crisis is a man-made mess, explaining:

“According to Boeing, about 80% of airplane accidents are due to human error. I think this fact, taken as a metaphor, can also work for the financial industry. What we are witnessing now is the crash of the economy based on ‘ruthless capitalism’, where compliance procedures and risk management were kept in a backyard stall, also known as a tick box exercise.”

Bradley Barnhorst, head of the finance major and CFP program director at DeSales University, told Cointelegraph that SVB’s fall can be attributed to mismanagement of the financial value of equity capital, a lack of protection against interest rate risk and a precipitous decline in deposits.

He recommended that banks should “adopt rigorous risk management processes and increase capital levels to protect against potential losses.”

Barnhorst further stated that banks need to diversify loan portfolios, be more selective with investments and “monitor and manage the risks associated with their investments to ensure they are not overexposed to any particular sector or industry.”

According to a recent study by Stanford University, 186 US banks are at risk of facing a bank run due to rising interest rates and a significant percentage of uninsured deposits. The study found that assets such as government bonds and mortgages can lose value when new bonds are issued with higher interest rates. Even insured depositors can experience a drop in value if half of the uninsured depositors suddenly withdraw their money from these 186 banks. The banks would not have enough assets to reimburse all depositors in full.

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Chris Barnes, managing director of finance at market data analytics firm Escalent, told Cointelegraph that 2008 was the last time banks faced a negative confidence environment, and 2023 could be another similar year.

Barnes explained: “The stress tests for large institutions are working and robust – it’s the downstream banks they’re worried about. Those banks were exempted from the 2018 regulatory changes.”

“If the rules had been in place, this would not have happened. As this unfolded, there was a lot of anger inside [Washington] DC because Silicon Valley Bank pushed so hard to get out of the regulatory loop (not very ironic). There needs to be a different kind of stress test for banks below significant financial institutions, he added.