Silvergate’s Solvency in Question as Crypto Banking Troubles Brew

Silvergate’s customers are fleeing as the share price plummets and regulatory questions mount across the industry. Crypto banking partner options are dwindling.

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Trouble is brewing in Crypto-Land

Developments surrounding crypto on-off ramps are heating up as Federal Reserve Bank member Silvergate Capital watches its depositors flee and its share price plummet. Along with Signature Bank, Silvergate is the other key bank in the US that works closely with the crypto sector.

The reason for the extreme concentration of banking interests willing to work in the crypto sector is the general lack of regulation on Know Your Customer and Anti-Money Laundering (KYC/AML) policy that exists in the offshore entity industry, as well as the problems with the wider industry being full of unregistered security offerings and many scams.

Of course, we believe there is a clear distinction between Bitcoin and the broad term colloquially called “crypto,” but the lines remain blurred for many regulators and government agencies.

Thus, in the past there have been very few entities in the US regulated banking system that have been willing to work with crypto firms to access the established USD on-and-off-ramps, presenting a unique challenge for companies dealing with transfer money and/or process payments and transactions.

Regarding Silvergate, we have been watching the situation closely since November – after the collapse of FTX – as it became clear that Silvergate played a role in servicing FTX and Alameda by giving them access to the USD rails.

As we wrote on November 17 (italics added):

“Who else is at the center of many institutions in the market? Silvergate Bank is one of them. Since the beginning of November, their shares have decreased by nearly 56%. Silvergate Bank is at the center of banking services for the entire industry, serving 1,677 digital asset customers with $9.8 billion in digital asset deposits. FTX accounts for less than 10% of deposits and the CEO sought to reassure markets that their the current loan portfolio has faced zero losses or liquidations to date. Leveraged loans are backed by bitcoins, which can be liquidated if needed. Still, the ongoing risk is the full accumulation of bank deposits at Silvergate. While the CEO’s comments sound reassuring, the stock’s performance over the past two weeks tells a much different story.” — The contagion continues: Major crypto lender Genesis is next on the chopping block

Since the FTX crash, shares of Silvergate Capital have fallen 83%, putting the current recovery from the all-time high at an impressive 97.3%.

As mentioned in the November 17th article, Silvergate’s share price did not crash due to the introduction of a crypto token, as was the case with many companies during the crypto winter of 2022, but rather from an outflow of deposits, which forced the firm to liquidate long-duration securities at a loss to remain liquid.

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As a traditional fractional reserve bank, Silvergate took customer deposits — which increased dramatically in 2021 — and lent them out over a long period of time, specifically in US Treasuries. In effect, businesses will loan their money to Silvergate by depositing at 0% to use their Silvergate Exchange Network (SEN), and Silvergate will then borrow those same dollars at a higher interest rate over a long period of time. It’s a great business model — as long as the value of your loans doesn’t fall at the same time as customers start withdrawing their funds.

“Customers withdrew about $8.1 billion in digital asset deposits from the bank in the fourth quarter, forcing it to sell securities and related derivatives at a loss of $718 million, according to a statement Thursday.” — Silvergate collapses after FTX implosion triggers $8.1 billion bank withdrawal

As comments about the incompetence and irresponsibility of Silvergate management have intensified, we need to interpret some of the nuances surrounding the situation.

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Most of Silvergate’s deposits came during a world of zero interest rate policy, where short-term Treasuries offered 0% yields. This phenomenon is one of the main reasons why Silvergate invests in long-term instruments. Bonds fall in value as global interest rates rise in 2022

With long-term debt securities, money is not lost in the event of rising interest rates as long as the bond is held to maturity (and not in default), but in the case of Silvergate, the runaway deposits forced the firm to realize that unrealized losses on their portfolio of securities—a nightmare for a partially preserved institution.

As solvency concerns have grown in recent months, companies have fueled speculation about exposure to the bank, with names such as Coinbase, Paxos, Circle, Galaxy Digital, CBOE and others reporting their banking relationships with Silvergate. Coinbase specifically announced its move to Signature Bank.

“We facilitate fiat withdrawals and deposits using Signature Bank, effective immediately.” — Note on Coinbase

One concern is that many of these firms turn solely to Signature Bank, which further centralizes the off- and on-ramps currently used by the crypto industry, even though Signature has a much larger market cap and a more diversified depositor base than Silvergate.

The current status of Signature’s digital asset deposit base is unknown, as the firm announced its desire to reduce reliance on crypto-related deposits in early December.

“Signature Bank (SBNY) will shrink its cryptocurrency-linked deposits by $8 billion to $10 billion, signaling a move away from the digital asset industry for the bank that until recently was one of the most crypto-friendly companies on Wall Street.

“We’re not just a crypto bank, and we want to make that clear and clear,” Signature Bank CEO Joe DePaolo said at an investor conference in New York hosted by Goldman Sachs Group on Tuesday.” — Coindesk

The timing of these events is significant due to the recent developments regarding the industry’s Silvergate breakout, coming at the same time as Signature appears to be limiting the use of its rails with key industry players.

One last note

After the disastrous 2022, regulators are stepping up their scrutiny of the crypto sector, and one of their main targets is the industry’s relationship with the legacy banking system. With Silvergate looking almost dead in the water with nearly every major player in the industry announcing plans to sever ties, the growing reliance on Signature Bank, a bank that has announced its intention to distance itself from the space, remains… alarming.

While this does not pose a major risk to the functioning of the Bitcoin network or its properties as an immutable settlement layer, the capping and increasing centralization of USD on and off is a key risk to short- to medium-term liquidity in Bitcoin and the broader crypto market.

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Related Past Articles:

  • The bigger they are…
  • Stock War: Binance Smells Blood as FTX/Alameda Rumors Increase
  • Crosshair crypto and bitcoin futures
  • Genesis files for Chapter 11 bankruptcy, owes more than $3.5 billion to creditors
  • Counterparty risk happens quickly
  • Shrinking Crypto Yield Offers Signal ‘Extreme Compulsion’
  • Crypto contagion intensifies: Who else is swimming naked?
  • The contagion continues: Major crypto lender Genesis is next on the chopping block

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