Crypto’s most ardent supporters present it as the future alternative to regular money. What they sometimes fail to mention is that, for now, most digital currencies still depend on old-fashioned banks for their existence. The need for “on and off ramps” to convert crypto to traditional currencies and back, and the risks this creates, were demonstrated in March when two crypto-friendly US banks collapsed. The glitches made it harder for investors to transfer cash to digital assets, raising a question: Is mainstream banking’s brief fling with unconventional finance already over?
SVB, Silvergate and why crypto still needs banks
1. What are “on-ramps” and “off-ramps”?
An on-ramp is a place where you can exchange regular currencies such as US dollars or euros for cryptocurrencies such as Bitcoin or Ether. Off-ramps allow you to exchange crypto-assets for traditional money. This mostly happens on crypto exchanges like Coinbase and Kraken as they can accept money through bank transfers or credit card payments. It is possible to trade crypto-tokens “peer to peer” without using a regular bank, but as very few products or services can be purchased with digital currency, investors usually have to liquidate before the proceeds can be used.
2. Where do the banks come in?
Crypto exchanges have been able to act as gateways between real and digital money due to their partnerships with banks such as Silvergate Capital Corp. and Signature Bank. The exchanges relied on services such as the Silvergate Exchange Network and Signature’s Signet to allow crypto clients to make real-time payments in dollars at any time, seven days a week, matching crypto’s own 24/7 trading hours.
3. Why did these banks collapse?
A confluence of misfortunes brought down Silvergate, Signature Bank and another technology-focused lender, Silicon Valley Bank, not least the end of rock-bottom interest rates. Crypto volatility also played a role:
• Silvergate invested some crypto-related deposits in mortgage-backed securities and bonds sold by state and local governments whose value fell as benchmark interest rates rose. When crypto markets crashed in 2022 and exchanges like FTX hit the wall, customers rushed to cash out. Silvergate had to sell securities to fund those withdrawals, losing more than $1 billion along the way and hastening its demise.
• Signature began pulling back from digital assets after the FTX explosion, but still had $16.5 billion in crypto-related client deposits as of March 8. It appears to have nervous depositors already shaken by SVB’s demise, prompting a run on deposits.
• SVB’s failure was largely attributed to their exposure to falling tech startup values and some unwise bond investments. It was also a useful partner for a prominent crypto firm: US stablecoin operator Circle said it had $3.3 billion USD Coin reserves deposited in the bank.
4. What was the immediate impact?
The demise of Silvergate and Signature left crypto firms struggling to find new banks for custody and payment services. Some financial firms imposed lengthy application procedures, rejected smaller companies and retail platforms, and in some cases closed the door to crypto businesses altogether, according to industry participants, investors and bank executives. That was one reason digital assets like Bitcoin became more difficult to trade in early April, with a measure of how easily the biggest cryptocurrency can be bought or sold falling to a 10-month low. This drop in liquidity threatened to exacerbate Bitcoin’s notorious price volatility and suggested that the token’s partial recovery from the “crypto winter” of 2022 may be built on a weak foundation.
5. What does it mean for crypto regulation?
Banking regulators have long taken a dim view of crypto. Its volatility makes it a potential source of unsustainable losses for investors and instability for the wider financial system. Critics say it can be used by bad actors to shift their ill-gotten gains without the checks and oversight required by regular banks. And it is difficult to verify the value of reserves that can serve as collateral when a crypto asset or institution suffers from a crisis of confidence. Regulators were now looking to fix the weaknesses in the US banking system exposed by Silvergate, Signature and SVB, one of which is the exposure of smaller lenders to volatile crypto assets. It marks a U-turn for a government that until recently had sought a lighter approach for smaller banks, to allow them to innovate in areas such as digital currencies.
6. What is the government doing about it?
The first target of official action was Silvergate. US prosecutors in the Justice Department’s fraud unit investigated the bank’s dealings with FTX and the trading company Alameda Research. The criminal investigation examined accounts hosted by Silvergate for FTX co-founder Sam Bankman-Fried’s businesses. The investigation touches on what banks and intermediaries working with Bankman-Fried’s firms may have known about what officials have called a scheme to defraud investors and clients. The bank is not accused of any wrongdoing, and the investigation can be concluded without charges being brought.
7. Can the bank failures sink crypto?
Even if regulators don’t ban US banks from handling digital tokens, the crypto world is likely to face costly, protracted distortions to move funds to and from US banks, which is likely to slow down settlements. A similar scenario unfolded in India in early 2022. Trading volume fell after several crypto exchanges had to suspend rupee deposits as banks and payment gateways withdrew support for money transfers. With US regulators seemingly determined to cut banks’ exposure to crypto, many crypto firms began searching for alternative banking partners in places like Switzerland and the United Arab Emirates. American investments in crypto may also suffer. Until recently, many of the country’s banks were experimenting with crypto and related blockchain technology, suggesting that the new asset class may eventually become mainstream. It is less certain now.
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