Traditional banks remain critical to Crypto’s future success

2023 has seen the relationship between banks and crypto firms drift further apart. Previous major events, including the collapse of FTX, Three Arrows Capital, and the Terra Luna crash, have led to calls for crypto self-storage, arguing that some exchanges could not be trusted. Banks seem to be battling their own problems as they try to distance themselves from crypto businesses.

What followed was a gradual reduction in bank support for crypto firms, which along with monetary tightening fueled the narrative that the banking system could not be trusted and that investors could adopt crypto as an alternative monetary system.

One of the most prominent proponents of this narrative in recent weeks has been former Coinbase CEO Balaji Srinivasan.

Recently, in a Twitter thread, Srinivasan predicted that Bitcoin would reach $1 million by June 17, 2023, more than a 3,000% increase from today’s price.

More broadly, however, millennials are seen as torchbearers of a “debanked” future, according to a recent Bankless report, which found that most of the demographic believe Bitcoin will become mainstream in the coming years. Many had their views on financial institutions influenced by the financial crisis in 2008.

However, banks offer a crucial link to the fiat money system. Without them, most crypto traders could not easily acquire crypto and participate in decentralized finance protocols.

The Practical Role of Financial Institutions in Crypto Trading

An example of this is Silvergate Bank, which filed for voluntary liquidation on March 8, 2023. The bank allowed traders to convert between fiat and crypto around the clock using the Silvergate Exchange Network. The payment rail allowed traders to exchange between crypto and fiat if they and the exchange they were trading on banked with Silvergate.

However, without this crucial lifeline, crypto firms would struggle to enable retail trading in the early days.

The co-founder of failed exchange FTX, Sam Bankman-Fried, said he could not overstate the role Silvergate played in the success of crypto exchanges.

“Life as a crypto firm can be divided into pre-Silvergate and post-Silvergate,” the defendant’s former CEO wrote on Silvergate’s website. Further adds:

“It’s hard to overstate how much it revolutionized banking for blockchain companies.”

How Circle lost access to Stablecoin reserves at SVB

Even stablecoins pegged to the value of government-issued currencies recently showed their reliance on banks.

Investors rely on stablecoins to provide on- and off-ramps into the crypto ecosystem. An investor can use stablecoins to buy and sell other cryptocurrencies faster than with fiat. Issuers of stablecoins backed them with reserves of on-chain or off-chain assets. Popular off-chain reserve assets include US Treasuries and cash.

USDC issuer Circle recently had to appease investors who cashed in over $1 billion of the stablecoin after a run on Silicon Valley Bank. Circle held 25% of the reserves backing USDC at SVB. In an announcement released it TwitterCircle stated that only 25% of USDC reserves held in cash were stored with banks.

Circle added that SVB was one of six banking partners that the company used. Furthermore, operations were not affected, with the announcement adding:

“While we await clarity on how the FDIC receivership of SVB will affect depositors, Circle & USDC continue to operate as normal.”

At 10:50 PM ET on March 10, 2023, Circle said it was unable to withdraw about $3.3 billion in reserves from the bank. According to the report, SVB had not processed the transfers Circle initiated on Thursday. That same day, federal regulators took control of the bank.

Around the same time, Coinbase said the exchange would stop processing USDC to USD conversions. During periods of high transaction volume, the conversions depended on dollar transfers from banks that cleared during normal business hours.

Banks and crypto can make business mutually beneficial

While established companies like Coinbase and Circle seem to secure alternative banking partners with relative ease, crypto startups have recently struggled in this area. Strict on-boarding requirements mean these firms face cumbersome paperwork or flat rejections.

Following the collapses of Silvergate, SVB and Signature Bank, smaller institutions are performing stricter due diligence. Since this new approach, users have experienced longer wait times for approvals. The banks want to avoid being the target of US regulators for introducing systemic risk into the financial system.

However, attracting deposits can increase banks’ balance sheets and restore confidence in the banking system. Non-crypto-based banks also have the advantage of catering to a wider range of industries. This diversified exposure will reduce their liquidity risk should a crisis occur in a specific industry, leading to mass withdrawals.

Puerto Rico-based FV Bank’s CEO recently said it would offer solutions to firms that adhere to “strict compliance and risk requirements.”

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