oh oh! The crypto collapse has reached the real financial system
Update, March 8, 7 p.m. ET: Silvergate has announced it is shutting down, original story follows below.
Update, March 12, 8 p.m. ET: Federal regulators have announced that Signature Bank has also closed.
Silvergate, one of the major banks in crypto, is in deep trouble. Maybe existential problems.
Silvergate didn’t get its start in crypto. It started in real estate. But in January 2014, the bank jumped into Bitcoin, a volatile year – Bitcoin started the year at $770 and closed above $300 in December. “Some of the companies that were set up at the time to provide services to this burgeoning Bitcoin space had a lot of trouble finding and maintaining bank accounts,” Silvergate CEO Alan Lane said in a June 2022 episode of the Odd Lots podcast. “So that’s where we really started.”
“We’ve got them all,” Lane said in 2022. “All the important ones.”
The focus at the bank has been on institutions – other businesses, some of which work with consumers. For example, Genesis, DCG’s now-bankrupt crypto lending subsidiary, was one of Silvergate’s first clients. The bank developed the Silvergate Exchange Network, a way for crypto institutions such as Coinbase, Gemini, and Kraken to conduct dollar transactions 24/7. “We’ve got them all,” Lane said in 2022. “All the important ones. Anyone who takes regulation seriously.”
Also among Lane’s customers: FTX. Federal prosecutors are now investigating Silvergate’s role in banking Sam Bankman-Fried’s fallen empire. The more pressing issue is that the collapse of FTX shocked other Silvergate customers, resulting in an $8.1 billion bank run: 60 percent of deposits ran out the door in just a quarter. (“Worse than the average bank experience during the Great Depression,” The Wall Street Journal helpfully explained.)
In the earnings statement, we found out that last quarter’s Silvergate results were absolute bullshit, a loss of $1 billion. Then, on March 1, Silvergate filed a surprise regulatory filing. It says quarterly results were even worse, and it’s not clear the bank will be able to continue.
In response, Coinbase, Galaxy Digital, Crypto.com, Circle, and Paxos have said they will stop using Silvergate — as will other less high profile clients. Tether, the controversial stablecoin that has had its own problems with banking, helpfully popped up to remind us that it wasn’t using Silvergate.
“If Silvergate goes bankrupt, it will push funds and market makers further overseas.”
The laundry list of customers helps explain why Silvergate’s woes are frightening. Very few banks will use crypto because it is so risky – and most traditional banks don’t let crypto clients transact in dollars 24/7. Access to banking that moves at the pace that crypto does is rare, and only one other US bank can do it.
“If Silvergate goes out of business, it will push funds and market makers further overseas,” John Wu, president of Ava Labs, told Barron’s. The problem is how easy it is to get into real cash dollars, which is called liquidity in financial terms. Less liquidity makes transactions more difficult. There is already a wider gap between the price at which a trade is expected to proceed and the actual price at which it is executed, Wu said.
So Silvergate’s problems are a problem for the entire crypto industry.
Silvergate’s SEN was a major entry and exit from the almighty dollar (and the almighty euro) to crypto. In 2022, Lane said all “regulated, US dollar-backed stablecoin issuers” banked with Silvergate.
But for stablecoins issued by Circle, Paxos and Gemini, among others, the SEN was important for the creation and burning of their tokens, which were spent when someone deposited a dollar into their Silvergate bank accounts, Lane said.
“We are this critical piece of infrastructure.”
Silvergate was a gateway for crypto. Stablecoins backed by dollars theoretically have at least some cash or cash assets in reserve somewhere. (The reason Tether is controversial is that there are questions about the existence and value of that reserve.) Silvergate’s job was to create a token when someone put a dollar in, say, USDC, and bought a token. burn when someone took out a dollar. “We are this critical piece of infrastructure where people, as they leave the ecosystem and want to go to money – those dollars go through Silvergate,” Lane said in 2022.
You’ll notice I say “was.” That’s because Silvergate announced on March 3 that it would be suspending SEN with immediate effect.
The dollar side of the transaction meant that Silvergate’s customers had to keep a lot of cash in the bank to pay each other and anyone who wanted to cash out. To make money here, Silvergate could do a few things. The safest thing to do is buy say one month Treasury bills from the Fed and call it a day.
Since these are finances, taking more risk can also yield more profit. So Silvergate seems to have bought bonds. (Bloomberg’s Verge favorite Matt Levine has a more in-depth breakdown of how this worked if you want the gory details.) The problem isn’t that the bonds were super risky — it’s that FTX caused a massive exodus to dollars, and Silvergate had to suddenly come up with a lot of money. Unfortunately, that meant selling his bonds at a loss to pay his obligations. Ironically, the bonds were quite safe – “if the depositors had kept their money with Silvergate, the bonds would have matured with enough money to pay them back,” Levine notes.
Silvergate has another way of touching stablecoins besides serving as an entry and exit point 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 begin 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 borrow dollars against Bitcoin. Now, Silvergate said on its fourth-quarter earnings call in January that “all of our SEN Leverage loans continued to perform as expected, with no losses or forced liquidations.” Maybe these loans are fine! Silvergate doesn’t appear to have done anything particularly risky elsewhere.
But if you want to use your Bitcoin to take out a dollar loan, I think that just got harder.
Silvergate had a life before crypto: it was a small bank focused on real estate transactions in Southern California. During that time, it never had more than $1 billion in deposits, according to The Financial Times. And Silvergate needed down payments. When Lane led the company into crypto, the business boomed. In 2021, Silvergate had more than $10 billion. The bank went public in 2019 at $12 per share and will peak at more than $200 per share in 2021. (Shares closed March 3 at $5.77.)
Real estate became less and less of a focus as crypto was a rocket ship for the bank. But that real estate connection turned out to be useful for Silvergate in 2022. In the last quarter of the year, Silvergate received at least $3.6 billion in funds from Federal Home Loan Banks, a 1930s system that originally also dealt in mortgages.
To pay that off, Silvergate sold more bonds. This isn’t ideal, and it’s part of why Silvergate is in trouble. “If you’re a bank, you don’t want to point in the wrong direction because that becomes self-fulfilling,” Bloomberg’s Levine writes. And indeed, this is why many of Silvergate’s large clients are shocked. Levine thinks this could make some regulators interested in crypto banking.
The Ministry of Justice is even interested. There are some questions about bizarre transactions that took place at Silvergate.
Binance for example. The supposedly independent arm, Binance.US, has transferred more than $400 million to a trading firm called Merit Peak Ltd, Reuters reported. That company is led by Binance CEO Changpeng Zhao. “The then CEO of Binance.US, Catherine Coley, wrote a letter to a Binance CFO in late 2020 asking for an explanation for the transfers, calling them ‘unexpected’ and saying ‘no one mentioned them,'” Reuters wrote. Those transfers took place on Silvergate’s dedicated network, 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 money with that of the trading company.
I don’t know if Silvergate did something wrong. Possibly not! But let the FBI sniff around and ask questions? That’s headache and distraction. It is the last thing a troubled bank needs.
Many companies that have banked with Silvergate have talked here about how they have minimal exposure to it, which is not a good sign historically. (See: Bankman-Fried’s infamous “FTX is fine. Assets are fine” tweet.)
But you know what? In this particular case, I tend to believe them. First, a lot of money has already left Silvergate. But secondly, Silvergate was a crypto pass-through bank; it held no reserves and paid no interest. The problem here is not so much that an exchange or stablecoin will suffer a huge loss of client money, but more that it is now even harder for crypto companies to get into the bank.
The crypto industry desperately needs banks. But both of Silvergate’s competitors, Metropolitan and Signature, pulled out of the industry before this debacle. Metropolitan said in January that it was running out of crypto altogether. And in December, Signature said it would cut $8 billion to $10 billion in digital asset-related funds.
I don’t know if Silvergate will get through this. But I strongly suspect that it just got a lot harder to exchange dollars and crypto. Silvergate traded in liquidity and a liquidity problem can very quickly become a solvency problem. The entire crypto industry just got a whole lot more vulnerable.