Small banks are going on a wild ride thanks to crypto

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When big banks steered clear of cryptocurrency companies, a handful of small lenders eagerly courted the booming businesses. Now they are dealing with the bust.

Silvergate Capital,Signature BankandCustomers Bancorphavesnapped up billions of dollars in depositsfrom crypto businesses the exchanges, investment firms and stablecoin issuers that grew rapidly alongside the market for digital currencies.

The plunge in crypto prices this year has taken the banks on a wild ride. At Silvergate, deposits swung by $5bn in the second quarter, a nearly unheard of move for a bank of its size, before ending basically flat at $13.5bn. filed for bankruptcy.

Volatility also has seeded into the banks stocks, which now trade more like crypto firms than their staid banking peers. The shares of Silvergate and Signature both doubled last year when the market was booming, while Customers stock more than tripled. Silvergate is down nearly 30% this year, while Signature and Customers are off almost 40%. The broad Nasdaq Bank index has fallen 8%.

Big banks have been snatching market share from small banks for years, especially when it comes to deposits. That has left smaller banks looking for growth in places where the big banks arent. With crypto, the difficulty of the strategy is obvious.

Banks typically want sticky deposits stable, low-cost funding that allows them to make more long-term loans. In the most extreme scenario, an unstable deposit base can make banks more prone to runs where customers ask for their money back faster than the bank can deliver it. A plunging stock price can make it harder for a bank to raise the money it needs to operate.

The crypto-focused banks aren’t holding digital currencies. Instead, they provide corporate bank accounts for crypto companies. They also operate special payments networks: A hedge fund buying bitcoin through exchange Coinbase Global, for instance, could use dollars from the funds Silvergate checking account to almost instantly cover the purchase.

More deposits usually allow a bank to increase lending. But these banks arent growing their loan books as fast as they are building deposits, opting instead to keep a bigger cushion to account for unexpected outflows. Silvergate and Signature posted record profits in the second quarter, despite the dramatic moves in the crypto market.

This is all just par for the course, said Silvergate chief executive Alan Lane. Weve set things up to essentially thrive during these times of market dislocation.

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In 2013, Silvergate was a commercial real estate lender with a handful of branches in the San Diego area in search of deposits. The bank opened to crypto companies the next year, and its deposits have since grown 30-fold, with 99% of them coming from the digital-currency world. The bank has sold off most of its traditional banking business to concentrate on crypto companies and institutional investors, banking well-known exchanges such as FTX, Coinbase and Kraken.

Early in the year, a decline in cryptocurrency trading volumes meant clients needed fewer deposits. The Maycollapse of terraUSD, a stablecoin pegged to the dollar, sent losses rippling through crypto exchanges and brokers, causing prices to plunge and kicking off a trading frenzy. Silvergates deposits went as high as $17.6bn and down to $12.6bn in the second quarter.

The bank said it hasnt lost any money on its $1.4bn portfolio of loans backed by bitcoin, though the digital currencies value has halved this year. Silvergate requires collateral far above the value of the borrowings.

In 2018, Signature Bank hired bankers specializing in crypto, part of an effort to branch out beyond commercial real estate.

Since the bank unveiled its own payments system for crypto companies, total deposits have nearly tripled to $104bn. Crypto-linked deposits made up 26% of the tally at the end of the second quarter.

One of Signatures customers, crypto lender Celsius Network, filed for bankruptcy in July. In court papers, Celsius said it had $130m in cash on hand and nearly all of its bank accounts were at Signature. Signature has experience working with clients in bankruptcy, and Celsius accounts for a small part of its deposits, chairman Scott Shay said in an interview.

A $2.4bn decline in digital-asset deposits in the second quarter dragged down total deposits.

Were banking a lot of companies, and its not our job to pick the winners and losers, Shay said.

Pennsylvania-based Customers Bank started pursuing crypto-company deposits less than a year ago. Its payments system has attracted more than $2bn so far, a sizable sum for a bank with $17bn in deposits.

Crypto customers withdrew hundreds of millions of dollars on some days in the second quarter, often to meet customer redemptions, said Christopher Smalley, the banks head of digital banking. Still, crypto-linked deposits grew, albeit more slowly.

Its worth us taking the risk that there will be negative news events or additional regulatory scrutiny to get these very large deposits, Smalley said. Were prepared for an extinction-level event where bitcoin would go to zero.

The bank, he said, has also beefed up its anti-money-laundering team. It is rolling out loans backed by customers crypto. Co-branded credit cards with exchanges and other projects could be next, Smalley said.

New York-based Metropolitan Commercial Bankheld deposits for customers at exchanges and partnered with exchange Crypto.com to issue a prepaid debit card backed by investors crypto holdings. Metropolitan holds $270m in customer deposits for exchange Voyager, which went bankrupt last month. It now could lose the whole chunk, about 4% of its total deposits, when those customers are paid back.

Metropolitan said it is pivoting away from crypto, looking to bank financial technology companies instead.

Soma Biswas contributed to this article.

Write to David Benoit at[email protected]and Rachel Louise Ensign at[email protected]

This article was published by Dow Jones Newswires, a fellow Dow Jones Group service

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