Oh oh ! The Crypto Collapse Has Hit the Real Financial System

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Silvergate, one of the most prominent crypto banks, is in deep trouble. Maybe an existential problem.

Silvergate did not start in crypto. It all started in real estate. But in January 2014, the bank jumped on Bitcoin, a volatile year. Bitcoin started the year at $770 and closed above $300 in December. Some of the companies forming at the time to provide services to this budding bitcoin space, many of them were struggling to find and maintain bank accounts, Silvergate CEO Alan Lane said in a statement. June 2022 episode of the Odd Lots podcast. So that’s really where we started.

We have them all, Lane said in 2022. All major.

The bank has focused on institutions and other businesses, some of which work with consumers. For example, Genesis, DCG’s bankrupt crypto-lending subsidiary, was among Silvergates’ first clients. The bank developed the Silvergate Exchange Network, which was a way for crypto institutions such as Coinbase, Gemini, and Kraken to conduct dollar transactions 24/7. We have them all, Lane said in 2022. All major. Anyone who is serious about regulation.

Also among Lanes clients: FTX. Federal prosecutors are currently investigating Silvergates’ role in Sam Bankman-Fried’s fallen empire. The more pressing issue is that FTX’s collapse spooked other Silvergate customers, leading to an $8.1 billion run on the bank: 60% of its deposits disappeared in a single quarter. (Worse than that suffered by the average bank during the Great Depression shutdown, the Wall Street Journal helpfully explained.)

In its earnings filing, we found that Silvergates last quarter results were absolute crap, a $1 billion loss. Then, on March 1, Silvergate filed a surprise regulatory filing. He says that in fact the quarterly results were even worse and that it is unclear whether the bank will be able to stay in business.

In response, Coinbase, Galaxy Digital, Crypto.com, Circle, and Paxos said they would stop using Silvergate as other less notable customers did. Tether, the controversial stablecoin that has had its own issues with banking, popped up helpfully to remind us that it doesn’t use Silvergate.

If Silvergate fails, it will push funds and market makers further offshore.

The long list of clients helps explain why Silvergates’ woes are frightening. Very few banks will touch crypto because its banks are so risky and most traditional banks don’t let crypto customers do dollar transactions 24/7. Access to banking services that keep pace with crypto is rare, and only another US bank can do it.

If Silvergate fails, it will push funds and market makers further overseas, Ava Labs president John Wu told Barrons. The problem is how easy it is to get real money, which in financial parlance is called liquidity. Less liquidity makes transactions more difficult. There is already a wider gap between the price at which a trade is supposed to take place and the actual price at which it executes, Wu said.

Silvergates’ problems are therefore a problem for the entire crypto industry.

Silvergates SEN was an important on and off ramp from the almighty dollar (and almighty euro) into crypto. In 2022, Lane said that all US dollar-regulated and backed stablecoin issuers were banking at Silvergate.

But for stablecoins issued by Circle, Paxos and Gemini, among others, the SEN was important for making and burning their tokens, which were issued when someone deposited a dollar in their Silvergate bank account, Lane said.

We are that critical piece of infrastructure.

Silvergate was a gateway for crypto. Stablecoins that are backed by dollars at least theoretically have cash or similar assets in store somewhere. (The reason Tether is controversial is that there are questions about the existence and value of this reserve.) Silvergates job was to create a token when someone put a dollar in, say, the USDC and burn a token when someone withdraws a dollar. We are this essential piece of infrastructure where people, as they leave the ecosystem and want to go and collect those dollars, come through Silvergate, Lane said in 2022.

You’ll notice I said was. That’s because on March 3, Silvergate announced it was suspending SEN, effective immediately.

The dollar side of the transaction meant Silvergates customers had to keep a bunch of cash on hand in the bank in order to pay themselves and anyone who wanted to cash out. To make money here, Silvergate could do a few things. The safest thing to do is to buy, for example, one-month Treasury bills at the Fed and stop there.

Now, this being finance, taking on more risk can also mean more profit. Silvergate therefore seems to have bought bonds. (Verge favorite Matt Levine at Bloomberg has a more in-depth analysis of how it worked if you want the gory details.) The problem isn’t that the bonds were super risky, it’s that FTX has sparked a massive dollar exodus, and Silvergate suddenly had to come up with a pile of money. Unfortunately, that meant selling his bonds at a loss in order to pay his obligations. Ironically, the bonds were pretty safe if its depositors had kept their money in Silvergate, its bonds would have matured with plenty of money to pay them back, Levine notes.

Silvergate has another way to touch stablecoins besides acting as an on- and off-ramp for their transactions. It bought assets from Facebook’s doomed stablecoin attempt Libra, later renamed Diem, in January 2022. At the time, Silvergate said it would start making Diem available by the end of the year. . The goal was a digital payment network.

One of the other services offered by Silvergate was the ability to lend dollars against Bitcoin. Now, Silvergate said in its January fourth quarter earnings call that all of our SEN leveraged loans continue to operate as planned, with no losses or forced liquidations. Maybe these loans are good! Silvergate doesn’t appear to have done anything exceptionally risky elsewhere.

But if you want to use your bitcoin to take out a dollar loan, I think that becomes more difficult.

Silvergate had a life before crypto: it was a small bank focused on real estate transactions in Southern California. During that time, he never had more than $1 billion in deposits, according to the Financial Times. And Silvergate needed deposits. When Lane steered the company into crypto, its business skyrocketed. In 2021, Silvergate had over $10 billion. The bank went public in 2019 at $12 per share and peaked at over $200 per share in 2021. (The shares closed at $5.77 on March 3.)

Real estate became less and less of a priority because crypto was a rocket ship for the bank. But that real estate connection has come in handy for Silvergate in 2022, however. In the last quarter of the year, Silvergate secured at least $3.6 billion in funds from the Federal Home Loan Banks, a 1930s system that also originally handled mortgages.

To repay this, Silvergate sold more bonds. That’s not ideal, and that’s part of the reason Silvergate is in trouble. If you’re a bank, you don’t want to point in the wrong direction because it becomes self-fulfilling, writes Bloombergs Levine. And indeed, that is why many major Silvergates customers are scared off. Levine thinks this might interest some regulators in crypto banking.

In fact, the Department of Justice is already interested. There are a few questions about the bizarre dealings that took place at Silvergate.

For example, Binance. Its supposedly independent arm, Binance.US, transferred more than $400 million to a trading company called Merit Peak Ltd, Reuters reported. This company is led by Binance CEO Changpeng Zhao. Binance.US CEO at the time, Catherine Coley, wrote to a Binance CFO in late 2020 asking for an explanation of the transfers, calling them unexpected and saying no one had mentioned them, Reuters wrote. These transfers took place on the special network Silvergates, SEN.

This is similar to some of the issues Silvergate is facing around FTX. Alameda Research, the trading company also owned by Bankman-Fried, opened an account with Silvergate in 2018. Bankman-Fried admitted to using Alameda accounts for FTX funds, mixing client funds with those of the trading company. .

I don’t know if Silvergate did anything wrong. Maybe not! But that the feds start snooping around, asking questions? It’s a headache and a distraction. It’s the last thing a troubled bank needs.

Many companies that have done business with Silvergate have spoken here about how little exposure they have to it, which historically isn’t a good sign. (See: Notorious Bankman-Frieds FTX is doing well. Assets are tweeting well.)

But you know what? In this specific case, I tend to believe them. First of all, just fucking money has already left Silvergate. But second, SIlvergate was a bridge bank for crypto; it has not kept any reserves and it has not paid any interest. The issue here is less that some exchanges or stablecoins are going to suffer a massive loss of customer money and more that it is now even more difficult for crypto companies to obtain banking services.

The crypto industry desperately needs banks. But Silvergates’ two competitors, Metropolitan and Signature, were pulling out of the business even before this debacle. Metropolitan said in January that it was getting out of crypto altogether. And in December, Signature announced it was getting rid of $8 billion to $10 billion in funds tied to digital assets.

I don’t know if Silvergate will make it. But I strongly suspect that it has become much harder to trade dollars and cryptos. Silvergate was trading cash, and a liquidity problem can become a solvency problem very quickly. The entire crypto industry has become much more fragile.

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