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If you've ever entered the crypto space through centralized exchanges, you've likely indirectly utilized Silvergate Bank. Silvergate is the largest crypto-friendly bank, with over 90% of its deposits coming from the crypto sector. Over the past decade, the bank has transformed from a small regional bank to a large institution with over $12 billion in deposits by the third quarter of 2022, servicing major crypto institutions like Coinbase, Gemini, FTX, and BlockFi.
After several months of turbulence, Silvergate appears to have succumbed to dual pressures from both regulatory scrutiny and market forces in the past week, experiencing a "bank run". The last straw came when Silvergate postponed the submission of its 10-K annual report to the U.S. Securities and Exchange Commission (SEC) by two weeks, citing the need for more time to assess its financial condition. Following this news, Silvergate's stock price plummeted by 55% to around $6.50 per share. JPMorgan analysts downgraded Silvergate's stock from "Neutral" to "Underweight".
In response, Silvergate's clients began to sever ties with the bank. Coinbase announced a shift to Silvergate's main competitor, Signature, quickly distancing itself from Silvergate. Other clients that have discontinued using Silvergate's services include Paxos, Crypto.com, Bitstamp, Cboe Digital Markets, Galaxy Digital, Gemini, and LedgerX. On April 12th, Silvergate was forced to suspend its Silvergate Exchange Network (SEN) operations, a zero-interest payment platform used by crypto companies for fiat transactions among themselves.
Concerns about Silvergate's bankruptcy had been brewing for months. During the crypto credit crisis of 2022, Silvergate experienced an $8 billion shrinkage. To maintain liquidity on its balance sheet amid the Federal Reserve's interest rate hikes to curb inflation in a high-interest rate environment, the bank was forced to sell $5.2 billion worth of bonds, resulting in a loss of $751.4 million. Silvergate also borrowed $4.3 billion in short-term loans from the Federal Home Loan Bank (FHLB) system, a government-sponsored shadow bank, to support domestic commercial banks in adverse market conditions.
Although Silvergate escaped relatively unscathed from the FTX collapse, it was not without consequences. The bank reported a loss of approximately $1 billion in the fourth quarter of 2022 and had to lay off 40% of its workforce (200 employees). Unfortunately, the bank's close relationship with FTX drew the attention of hawkish regulators, increasing reputation risks and investor uncertainties.
On December 6th, U.S. Senators Elizabeth Warren, John Kennedy, and Roger Marshall began investigating Silvergate's role in fraudulent transfers between FTX and Alameda, accusing the bank of "serious dereliction of duty in supervising and reporting suspicious financial activities of its clients". A subsequent press release from Silvergate stated that FTX's total deposits were less than 10% of its $11.9 billion in deposits.
Reportedly, on February 2nd, U.S. Department of Justice prosecutors began investigating Silvergate's relationship with FTX and Alameda.
In summary, Silvergate is buckling under the dual pressure of significant withdrawals and unfriendly regulatory scrutiny. The root cause of the problem is bad liabilities, not bad assets. Unlike Three Arrows Capital or FTX, the bank's run that Silvergate is experiencing is not due to the collapse of high-risk, high-leverage loans supported by volatile crypto collateral. As Matt Levine wrote in Bloomberg's "Money Stuff":
"The situation now is that Silvergate's clients are withdrawing their money because they're worried about Silvergate, 'given recent developments and out of an abundance of caution,' which is classic bank run. But they're not withdrawing their money for the same reason they might have at the end of 2022. They're withdrawing their money because crypto is crashing: Silvergate's crypto exchange clients are under pressure from their own customers to withdraw, so they're pulling money out of Silvergate. The clients—the crypto exchanges—are the problem, not Silvergate."
Ultimately, the ripple effects of the FTX collapse began to impact Silvergate. As a primary channel for rapid fund transfers for cryptocurrency market makers, Silvergate's demise is not a good sign for the industry.
The panic surrounding Silvergate led to a 4.8% decrease in the total market capitalization of cryptocurrencies during the ETH Denver conference.
This debacle also raises a critical existential question for cryptocurrencies: How can they survive without relying on the centralized TradFi track?
The simplest answer is "Don't use TradFi." However, in the short term, this may be too idealistic. The reality is that the crypto industry will to some extent rely on institutions under financial regulation to facilitate capital inflows and outflows.
If that's the case, the crypto industry must avoid putting all its eggs in one basket, as Silvergate did. Currently, a few crypto banks—especially Silvergate and Signature—provide convenient chokepoints and vulnerable targets for anti-crypto regulators.
Diversification of crypto banks is key, but the unfriendly actions of financial regulators and their generally unsupportive stance make it difficult for banks to adopt new financial technologies to serve crypto clients. This weakens the crypto industry and may make traditional, conservative financial institutions in the United States even less willing to risk innovation. |
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