Why Silvergate’s financial troubles after FTX could spell trouble for crypto
by Arthur · March 6, 2023
Crypto’s darkest days and biggest barriers to growth have stemmed from startups’ inability to secure banking relationships. With Silvergate Capital struggling to survive, many in crypto are worried that the industry could suffer a major and familiar setback: the industry being removed from the banking system. Furthermore, the spread to a traditional bank and its stock price could fuel regulators’ arguments that crypto poses a systemic risk. “Until now, we’ve been able to say that the fallout from everything that happened last year was contained within the crypto industry — painful, but contained,” said Noelle Acheson, economist and author of the Crypto is Macro Now newsletter. “If Silvergate goes down, regulators will be able to say ‘ah, systemic risk, we told you so.’ It will give them even more ammunition to go after crypto and increase their choke on fiat access for crypto businesses.” Shares in Silvergate, a famous crypto-friendly bank, fell 60% last week after the company delayed filing its annual report, citing to financial challenges related to the demise of former client FTX—specifically, “the sale of additional investment securities beyond what was previously anticipated.” Silvergate has come under increased regulatory scrutiny since the collapse of FTX. In February, Senators Elizabeth Warren (D-Mass. ), John Kennedy (R-La.) and Roger Marshall (R-Kan.) a letter to CEO Alan Lane accusing the bank of “further introducing crypto market risk into the traditional banking system” through its business relationship with FTX and its since-indicted CEO Director Sam Bankman-Fried The next day, the Justice Department said it was investigating the bank’s dealings with FTX and its sister company at Alameda Research. Crypto’s ‘dark age’ Silvergate didn’t start out as the “crypto bank” it is now, but it saw the early opportunity to service reputable crypto companies and has become a lifeline for US crypto startups. The big problem in crypto is that in order to buy bitcoin, you ultimately have to interact with the traditional banking system. Silvergate helped solve this problem by creating simple banking services for crypto companies, which mostly always struggled to find banking partners. In the past decade, Silvergate has become the go-to bank for cryptocurrency companies. “Crypto entities need banking services,” Acheson said. “No matter how ‘crypto’ you may be, you have to pay salaries, you have to pay utility bills, hosting fees, etc. “The lack of banking services in the crypto industry before Silvergate and Signature came along was one of the biggest barriers to progress,” she added. “That ended up with many entities opening accounts in rather dubious entities offshore.” For example, Tether, the stablecoin giant, and its sister company Bitfinex struggled to maintain access to the global banking system in 2018. The Wall Street Journal published an investigation Friday with new details about how the company used forged documents and turned to shady middlemen to Continue. Silvergate’s crypto game worked for the bank, especially in bull markets. The company reported about $7 billion in deposits at the end of the first quarter of 2021. This doubled by the end of the year, according to Silvergate’s accounts, at the end of 2019, and the end of the last crypto winter, the company had only $1.2 billion in deposits. A big part of Silvergate’s crypto banking work was the Silvergate Exchange Network, better known as SEN, a platform that institutions used to move money to crypto exchanges. Silvergate closed it late on Friday, but the bank’s deposit products are still operating. “Pretty much everyone in the crypto industry at some point has used Silvergate,” Acheson said, adding that it was not only because it was crypto-friendly, but also because it was “a recognized and regulated financial institution that would help them interact with fiat economy .” Restricted access The problems at Silvergate exacerbate the regulatory hostility facing the crypto industry. Investors were spooked last month by what appeared to be the beginning of a regulatory crackdown on US crypto companies – including the Securities and Exchange Commission’s enforcement action against Kraken, its Wells Notice of a future settlement against Paxos and the New York State Department of Financial Services’ order Paxos to stop minting Binance USD (BUSD) stablecoin. Coinbase suspended transfers to and from Silvergate last week and said it will work with Signature Bank, another well-established bank serving the crypto industry, going forward. Silvergate’s SEN handled $162 billion and $219 billion of transaction volume in the third and fourth quarters of 2021, respectively, according to the companies’ financial statements. In the same period, Signature’s answer to SEN, Signet, handled $127 billion in the third quarter and $213 billion in the fourth. Still, while crypto has Signature as an option, there is a dark cloud hanging over it. “They’re probably thinking along the same lines as a lot of other banks to try to roll back their crypto exposure because it’s just not worth it,” Acheson said of Signature. “The profits they make from the industry are unlikely to be offset by the additional compliance costs and legal fees they may incur.” “Every bank will do anything to avoid regulatory inspection – that’s one of the worst things that can happen to you because it’s expensive and affects the share price,” she added. “If a bank thinks that regulators will pay extra attention to them if they happen to serve crypto companies, … nobody wants that kind of attention.” SI 1Y mountain Silvergate, 1 year Silvergate’s stock has suffered several falls in 2023 alone. Before its 57% drop in one day last week, it fell 29% the day the DOJ investigation was reported, and before that, 42% in January after it disclosed massive withdrawals in the fourth quarter. The stock has fallen around 94% in the past year. 2021 bubble Coinbase was not the only one to suspend its relationship with Silvergate. Galaxy Digital, Circle, Paxos, Bitstamp and others did as well. It shows how much risk appetite entered crypto in the 2021 bull run, after years of investors shunning the asset class, according to Caitlin Long, CEO of Custodia Bank. Custodia is a Wyoming-chartered special purpose depository institution designed to bridge the gap between crypto and traditional banking systems. It was the “tip of the spear” of the current de-banking wave, Long told CNBC. Earlier this year, the application to become a member institution of the Federal Reserve was rejected. “The bank runs that have taken place prove the obvious: there is incompatibility between the traditional ‘borrow short and lend long’ business model of fractional reserve banks and rapid settlement of digital assets, because the bank’s demand deposits can literally be withdrawn within the time period So a bank may who lend the quick deposits don’t survive a bank run,” she said. “Until a couple of years ago, the banks serving the crypto industry understood this risk and held 100% cash to support demand deposits from crypto depositors, but during the 2021-22 bubble it seems some of the banks started taking unnecessary risks and oh boy, they’re paying for it now,” Long said.
