One of the key banks in the cryptocurrency industry, Silvergate, is in serious danger. Perhaps existential angst.
Silvergate didn’t begin in the crypto space. They started in Real Estate. Nonetheless, the bank entered the Bitcoin market in January 2014. It was a turbulent year; Bitcoin started the year around $770 and ended the year just above $300.
Alan Lane, CEO of Silvergate, noted on a June 2022 episode of the Odd Lots podcast that “several of the companies that were being founded at the time to give services to this budding Bitcoin space, many of them were having to get and retain bank accounts”. That was actually where we began, then.
In 2022, Lane declared, “We have them all. “All the significant ones.”
The bank’s attention was on institutions, or other businesses, some of which deal with customers. One of Silvergate’s first clients was Genesis, the now-bankrupt crypto-lending division of DCG. The bank created the Silvergate Exchange Network, which gave cryptocurrency companies like Coinbase, Gemini, and Kraken a 24/7 means of transacting in dollars. In 2022, Lane declared, “We have them all. “All the significant ones. anyone who takes regulation seriously.
FTX is another of Lane’s customers. Federal investigators are currently looking into Silvergate’s involvement in financing Sam Bankman-defunct Fried’s empire. The more urgent issue is that other Silvergate customers were alarmed by the failure of FTX, which led to a $8.1 billion bank run, wiping away 60% of its deposits in only one quarter. The Wall Street Journal kindly explained that the situation was “worse than that faced by the average bank that closed during the Great Depression.”
We learned through Silvergate’s quarterly statement that its third-quarter results were a complete disaster, a $1 billion loss. After afterwards, on March 1st, Silvergate filed an unexpected regulatory document. It claims that the quarterly numbers were actually significantly worse and that it’s doubtful the bank will be able to continue operating.
Coinbase, Galaxy Digital, Crypto.com, Circle, and Paxos have responded by announcing they’ll quit utilizing Silvergate, along with other, less well-known customers. The contentious stablecoin Tether, which has experienced its own banking issues, seems to remind us that it does not use Silvergate.
“If Silvergate fails, it will drive capital and market makers even further offshore.”
The long list of clients explains why Silvergate’s problems are terrifying. Because cryptocurrency is so dangerous, few few institutions will deal with it, and the majority of conventional banks don’t allow crypto clients to transact in dollars round-the-clock. There is just one other US bank that can provide access to banking that moves as quickly as cryptocurrency.
According to John Wu, president of Ava Labs, “if Silvergate falls out of business, it will force funds and market makers further offshore. The difficulty of obtaining actual cash money, or liquidity in financial parlance, is the problem. Transactions become more challenging when there is less liquidity. According to Wu, the difference between the expected and actual prices at which a trade is executed has already grown.
A crucial on- and off-ramp from the great dollar (and mighty euro) into cryptocurrency was Silvergate’s SEN. All “controlled, US-dollar backed stablecoin issuers,” according to Lane, banked at Silvergate in 2022.
But, the SEN was crucial for creating and burning their tokens, which were generated when someone put a dollar in their Silvergate bank accounts, for stablecoins issued by Circle, Paxos, and Gemini, among others, according to Lane.
We make up this essential component of the infrastructure.
A crypto pass-through point was Silvergate. Theoretically, stablecoins backed by dollars have cash or assets that are similar to cash on hand. (There are doubts regarding the existence and value of that reserve, which is why Tether is controversial.) When someone put a dollar into, let’s say, USDC, Silvergate was supposed to create a token and burn a token when someone took a dollar out. As people leave the ecosystem and seek out currency, their money pass through Silvergate, according to Lane in 2022.
As you can see, I used the word “was.” This is due to Silvergate’s March 3 announcement that SEN would be suspended immediately.
In order to pay each other and anyone who wanted to cash out, Silvergate’s clients had to keep a large amount of cash on hand at the bank due to the dollar side of the transaction. Silvergate has a few options for how to profit from this. Buying one-month Treasury bills at the Fed and calling it a day is the safest course of action.
While this is finance, taking on more risk might also result in greater financial gain. Silvergate appears to have purchased bonds, then. (If you’re interested in the bloody details, Verge fave Matt Levine at Bloomberg has a more in-depth examination of how this worked.)
The issue is not that the bonds were extremely risky; rather, it is that FTX caused a large-scale flight to dollars, forcing Silvergate to find a lot of cash quickly. Sadly, in order to fulfill its obligations, it had to sell its bonds at a loss. Strangely, the bonds were relatively safe — “if its depositors had maintained their money with Silvergate, its bonds would have matured with enough of money to pay them back,” observes Levine.
In addition to acting as the on- and off-ramp for stablecoin transactions, Silvergate provides another way of interacting with them. In January 2022, it acquired assets from Facebook’s failed stablecoin project Libra, which was eventually renamed Diem. By the end of the year, Silvergate promised to begin making Diem accessible. A network for digital payments was the target.
That was, of course, before FTX went bust, and the Enron guy claimed it was even worse. Such events frequently cause the regulatory environment to alter.
Silvergate also provided the option to borrow money in exchange for bitcoin. Yet, Silvergate reported in January that “all of our SEN Leverage loans continued to perform as expected, with no losses or forced liquidations” during its fourth quarter results call. Perhaps these loans are okay. There doesn’t seem to be anything particularly dangerous that Silvergate has done elsewhere.
But I think it just become more difficult if you want to use your Bitcoin to take out a dollar loan.
Before going crypto, Silvergate was a small bank in southern California that specialized in real estate transactions. According to The Financial Times, it never had deposits totaling more than $1 billion during that time. Silvergate also required deposits. The business of the company exploded once Lane led it into cryptocurrency. Silvergate had more than $10 billion by 2021. The bank listed in 2019 at $12 per share, reaching its high in 2021 at almost $200 per share. (Shares ended trading on March 3 at $5.77.)
Because cryptocurrency was a rocket ship for the bank, real estate started to receive less and less attention. But, Silvergate found use for that real estate relationship in 2022. Federal Home Loan Banks, a 1930s-era structure that first dealt in mortgages, provided Silvergate with at least $3.6 billion in funding in the final quarter of the year.
Silvergate auctioned off further bonds to cover that debt. This is not ideal, and it contributes to Silvergate’s difficulties. If you’re a bank, you don’t want to be pointing in the wrong direction because that will only make things worse, according to Levine of Bloomberg. And in fact, this is the reason why many of Silvergate’s top clients are alarmed. Levine believes that this might spark interest in crypto banking among some regulators.
Unusual transactions
The Justice Department is already intrigued, in fact. There are several concerns regarding the strange transactions that happened at Silvergate.
Binance, as an example. According to Reuters, its ostensibly autonomous arm, Binance.US, moved more than $400 million to a trading company called Merit Peak Ltd. Changpeng Zhao, CEO of Binance, oversees that company. In late 2020, Catherine Coley, the CEO of Binance.US at the time, wrote to a finance executive of Binance seeking an explanation for the payments, describing them as “unexpected” and asserting that “no one addressed them,” according to Reuters. The transfers happened over SEN, a network exclusive to Silvergate.
This is comparable to some of the FTX-related issues Silvergate has. In 2018, Alameda Research, a trading company that is also owned by Bankman-Fried, opened a Silvergate account. Bankman-Fried said he mixed customer monies with those for the trading company by using Alameda accounts for FTX funds.
I’m not sure if Silvergate committed any wrongdoing. Maybe it didn’t! Having the Feds, however, start looking around and enquiring? It is both an inconvenience and a diversion. The last thing a bank in crisis wants is that.
How to prepare
Many businesses that banked with Silvergate have been out here discussing how little exposure they have to it, which is traditionally not a good indicator. (See the infamous “FTX is acceptable” statement by Bankman-Fried. Tweet: “Assets are fine.”
But guess what? I think I’m inclined to believe them in this case. First off, Silvergate has already lost a fuckload of money. Yet, Silvergate was a pass-through bank for cryptocurrencies; it didn’t keep reserves and didn’t offer interest. The issue here is more that it is now even more difficult for cryptocurrency enterprises to obtain banking than it is that some exchange or stablecoin will suffer a big loss of consumer money.
The cryptocurrency market is in dire need of banks. But, even before this disaster, Silvergate’s rivals Metropolitan and Signature were leaving the market. Metropolitan declared in January that it was completely leaving the cryptocurrency industry. Also, in December, Signature said that it will liquidate $8 billion to $10 billion in funds tied to digital assets.
Whether Silvergate will survive this is an unknown. Yet I have a strong suspicion that exchanging money for cryptocurrency has become much more difficult. Silvergate dealt in liquidity, and a liquidity issue can quickly develop into a solvency issue. The entire cryptocurrency market has now become much more shaky.
