Silvergate's solvency in doubt as crypto banking woes brew

Silvergate clients flee as share price plummets and regulatory questions mount across the industry. The options for crypto banking partners are dwindling.

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Trouble is brewing in Crypto-Land

Developments around cryptocurrency on-ramps and off-ramps have been heating up, as Federal Reserve member Silvergate Capital Bank saw its depositors flee and its share price plummet. Along with Signature Bank, Silvergate is the other key US bank that works closely with the cryptocurrency sector.

The reason for the extreme concentration of banking interests that are willing to deal in the cryptocurrency sector is the general lack of regulation around know-your-customer and anti-money-laundering (KYC/AML) policy that exists in the industry. for offshore entities. as well as problems with the industry in general, which is plagued by unregistered securities offerings and many frauds.

Of course, we believe that there is a clear distinction between bitcoin and the broad term known colloquially as “crypto”, but the lines remain blurred for many regulators and government agencies.

Thus, historically there have been very few entities in the US regulated banking system that have been willing to work with cryptocurrency firms to access the on-ramps and off-ramps set in USD, which presents a unique challenge. for companies that are in the business of moving money. and/or payment and transaction processing.

Regarding Silvergate, we have been monitoring the situation closely since November, following the FTX crash, when it became apparent that Silvergate played a role in servicing FTX and Alameda by giving them access to USD rails.

As we wrote on November 17 (emphasis added):

“Who else is at the center of many institutions in the market? Silvergate Bank is one of those. Since early November, its shares are down nearly 56%. Silvergate Bank is at the nexus of banking services for the entire industry, serving 1,677 digital asset clients with $9.8 billion in digital asset deposits. FTX accounted for less than 10% of deposits and the CEO has tried to reassure markets that his the current loan book has faced zero losses or liquidations so far. Leveraged loans are collateralized with bitcoins that can be liquidated as needed. However, the current risk is an outright run on the Silvergate deposits. Although the CEO’s comments sound reassuring, the stock’s performance over the past two weeks tells a very different story. — Contagion Continues: Major Crypto Lender Genesis Is Next on the Chopping Block

Since the FTX implosion, Silvergate Capital shares have fallen by 83%, putting the current highest price reduction of all time at a staggering 97.3%.

As mentioned in the Nov. 17 article, Silvergate’s share price is not crashing due to the performance of a crypto token as was the case for many companies in the crypto winter of 2022, but rather due to an exodus of deposits. which has forced the company to liquidate for a long time. -duration securities at loss in order to remain liquid.

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As a traditional fractional reserve bank, Silvergate took customer deposits, which increased dramatically in 2021, and lent them out over an extended period, particularly in US Treasuries. In practice, companies would lend their money to Silvergate depositing at 0% to use its Silvergate Exchange Network (SEN), and Silvergate would then lend those same dollars at a higher interest rate over a long period of time. This is a great business model, as long as your loans don’t lose value at the same time that customers are withdrawing their funds.

“Customers withdrew about $8.1 billion from the bank’s digital asset deposits during the fourth quarter, forcing it to sell related securities and derivatives at a loss of $718 million, according to a statement on Thursday.” — Silvergate Falls After FTX Implosion Sparks $8.1 Billion Bank Run

As talk of the Silvergate administration’s incompetence and irresponsibility mounts, we must interpret some of the nuances surrounding the situation.

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Most of Silvergate’s deposits came during a world of zero interest rate policy, where short-duration Treasuries offered a 0% yield. This phenomenon is one of the main reasons why Silvergate invested in longer-lasting instruments. The bonds fell in value as global interest rates rose throughout 2022.

With long-duration debt securities, money is not lost if interest rates rise as long as the bond is held to maturity (and does not default), but in the case of Silvergate, the flight of deposits forced the company to make the payment. unrealized losses on your stock portfolio, a nightmare for a fractional reserve institution.

With solvency concerns rising in recent months, companies faced speculation about exposure to the bank, with names like Coinbase, Paxos, Circle, Galaxy Digital, CBOE and others communicating about their banking relationships with Silvergate. Coinbase explicitly announced its move to Signature bank.

“We are facilitating withdrawals and fiat deposits using Signature Bank, effective immediately.” — Coinbase Note

One concern is that many of these companies turn solely to Signature bank, which further centralizes the on-ramps and off-ramps currently used by the crypto industry, despite Signature having a much larger market capitalization and depositor base. more diversified than Silvergate.

The current status of Signature’s digital asset deposit base is unknown, as the firm communicated its desire to reduce reliance on cryptocurrency-related deposits in early December.

“Signature Bank (SBNY) will reduce its cryptocurrency-linked deposits by between $8 billion and $10 billion, signaling a move away from the digital asset industry for the bank that until recently had been one of the most crypto-friendly companies around. cryptocurrencies on Wall Street.

“We are not just a crypto bank and we want that to come across loud and clear,” Signature Bank CEO Joe DePaolo said at an investor conference in New York hosted by Goldman Sachs Group on Tuesday. — Coindesk

The timeline of these events is important due to recent developments regarding the industry’s flight from Silvergate at the same time that Signature appears to be handcuffing the use of its rails with key industry players.

Final note

After a disastrous 2022, regulators are stepping up their careful scrutiny of the cryptocurrency sector, with one of their main targets being the connection between the industry and the legacy banking system. As Silvergate appears to be all but dead in the water with almost every major industry player announcing plans to sever ties, the growing reliance on Signature Bank, a bank that has announced its intention to distance itself from the space, remains…concerning. .

While this does not pose a fundamental risk to the functioning of the Bitcoin network or its properties as an immutable settlement layer, the crackdown and increasing centralization of USD on-ramps and off-ramps is a key liquidity risk in the short term. and medium term in bitcoin. and broader crypto market.

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