Silvergate Capital can perform well even when the price of Bitcoin does not

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Many publicly traded companies that operate in the cryptocurrency space tend to have stocks that closely track the price of bitcoin (CRYPTO: BTC), the largest cryptocurrency and the pioneer of digital currencies and blockchain technology. What I mean by that is when the price of bitcoin goes up, so do associated stocks, and vice versa.

Silvergate Capital (NYSE: SI), a bank that operates in the crypto space, has also been lumped into this category, which makes some sense given its business model. But after seeing Silvergate’s second quarter results, I think there is good reason to believe that the bank’s performance, at least on an earnings basis, is not necessarily correlated with the price of Bitcoin. Here’s why.

Image source: Getty Images.

An excellent second quarter of profits

Several years ago, Silvergate Capital built its own internal payment system called Silvergate Exchange Network (SEN). SEN is a payment network that can clear transactions in US dollars at any time, 365 days a year, between two network users (cryptocurrencies are traded 24 hours a day).

SEN is ideal for banking, as institutional traders bring large amounts of fixed, fee-free deposits with them, allowing Silvergate to grow their deposits quickly and without having to pay interest to depositors. These deposits essentially serve as a source of free funding that Silvergate can lend and earn interest on. If you look at Silvergate stock since early 2020, it has traded broadly in line with the price of Bitcoin.

Data by YCharts.

In the second quarter, as the price of Bitcoin fell from a high of $ 65,000 to below $ 30,000 at times, Silvergate shares also tended to fall. But the results of this period showed that the company had an exceptional quarter of profits. Earnings per share (EPS) of $ 0.80 was up 45% from the first quarter and 176% year-over-year.

Net interest income, which is mostly earned on loans and securities, increased 32% from the previous quarter as the bank invested $ 4.5 billion of excess cash in securities. It also continued to grow its portfolio of specialized SEN Leverage loans by nearly 32%. SEN Leverage is a line of credit in US dollars guaranteed by bitcoin. The total volume of over $ 258 million represents an increase of more than 10 times over the period of the previous year. Another good sign for SEN Leverage is that despite the significant drop in the price of bitcoin, which is again the collateral behind these loans, there has been no loss and no forced liquidation. Commission income at the bank hit a record $ 12.1 million in the quarter, up 59% from the previous quarter and 317% year-over-year, largely due to due to the increase in commission income from digital currency customers.

Strong performance driven by factors other than bitcoin

Many of the positives that drove revenue in the second quarter weren’t just related to bitcoin. The thing about SEN is that it’s a network, and you have to be there to interact with others, so as the network grows, it becomes more attractive to join. Despite the drop in the price of bitcoin, Silvergate has onboarded 120 more customers into the network, which is not too lower than the number it onboarded in the first quarter. In addition, while the number of transactions on SEN decreased from the first quarter, the total dollar volume sent through the network increased by 44% sequentially.

Image source: Silvergate Capital Q2 Investor Presentation.

Silvergate Chief Strategy Officer Ben Reynolds attributed the divergence in trade numbers and volume to clients keeping more cash in the bank through deposits than they needed to actually execute their trades, resulting in larger transfers per transaction but fewer overall transfers. Silvergate CEO Alan Lane said the pipeline of potential new digital currency customers for SEN remained “strong”.

SEN Leverage also managed to grow well in the quarter, despite the decline in bitcoin prices. Reynolds said that despite market conditions, the “need for greater capital efficiency” is not disappearing in the digital currency market. He remained optimistic about the future growth of SEN Leverage.

Lane attributed the growth in commission income during the quarter to the fact that there is often a time lag between when customers move to the SEN network for trading and when they can start profiting. other products that the bank may offer, such as more traditional ACH transfers or foreign exchange products. Lane said that due to this factor growth will continue to be erratic going forward, but he feels that overall the bank is in its infancy.

Another big sign for Silvergate

I’ve been bullish on Silvergate for a while now, but surging earnings despite the bitcoin price drop makes me even more confident. While the stock may still move in line with bitcoin in the near term, and earnings may be slightly erratic, as management has said, this recent quarter shows that Silvergate’s fundamentals should allow it to succeed without having to rely solely on the price of bitcoin. As the SEN network grows, it becomes more and more attractive for customers to join. Ultimately, I agree with management that the bank is in the early stages of digital transformation and still has a lot of potential.

This article represents the opinion of the writer, who may disagree with the official recommendation position of a premium Motley Fool consulting service. Were motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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