Silvergate Bank’s Exit: A Turning Point for Crypto Banking?

Contents

Silvergate Bank, a former crypto-friendly bank, suffered significant liquidity problems due to the decline in cryptocurrency markets in 2022 and the collapse of the crypto exchange FTX.
These events led to a significant outflow of funds, resulting in a $1 billion net loss for common shareholders during the last quarter of 2022.
The bank compensated for the loss by selling its bonds, which became expensive due to increased interest rates.
Silvergate Bank has decided to discontinue its crypto banking operations, citing recent regulatory changes as one of the reasons for the decision.
However, the U.S. government’s crackdown on the crypto industry may result in more banking partnerships in the future. These partnerships could be of better quality and quantity.

Since FTX went out of business, several crypto companies and cryptocurrency markets have been badly affected, and Silvergate is the latest victim. Silvergate announced a loss of over $1 billion and an $8 billion run on deposits, which caused investors to lose trust in the bank.

The holding company for Silvergate Bank, Silvergate Capital Corporation, stated that the best course of action is to orderly wind down the bank’s operations and voluntarily liquidate the bank.

The fall of Silvergate is a rare occurrence of cryptocurrency volatility impacting traditional banking. Despite being a traditional, federally insured institution, the bank had established itself as a point of entry into the world of digital assets.

In this article, we delve into the events that contributed to Silvergate bank’s downfall and discuss how this collapse will impact the crypto banking sector. Furthermore, we will examine the key takeaways from this incident and what lies ahead for both the bank and the industry as a whole.

An Overview of Silvergate Bank’s Relationship With The Crypto Industry

Silvergate Bank was initially established in 1988 in San Diego, California, as a small local bank. However, it grew to become a major financial service provider to the cryptocurrency industry.

As early as the 2010s, Silvergate Bank began offering banking services to cryptocurrency exchanges such as Coinbase and Kraken, making it one of the pioneers in providing financial services to the emerging digital currency sector.

In 2013, the bank introduced the Silvergate Exchange Network (SEN), which allowed customers to transfer U.S. dollars between exchanges around the clock. The SEN platform revolutionized the digital currency industry by providing a fast and affordable way to transfer money between exchanges.

In 2018, Silvergate Bank became the first American bank to go public, raising $40 million from its IPO. The bank used the funds to expand its services to cryptocurrency clients.

What Exactly Happened to Silvergate Bank?

Silvergate Capital created a crucial infrastructure for the cryptocurrency ecosystem by establishing a payment network capable of swiftly clearing and settling fiat transactions between two parties on the network at all times. Institutional traders and crypto exchanges liked the network because crypto trades happen all the time, which is different from the U.S. financial system.

However, after the FTX crash, things started going downhill at Silvergate. Concerns over whether Silvergate may face regulatory action for its relationship with FTX, a significant client of Silvergate’s, caused a crisis of trust inside the bank. The U.S. Department of Justice also began investigating the bank.

In the fourth quarter of 2022, almost 70% of Silvergate’s deposits left the bank. This forced the company to sell a large part of its bond portfolio at a loss and took away a large amount of shareholder equity. Most bonds now have negative yields due to rising interest rates.

In the most recent quarter, more bonds were sold, which led to more losses and could have put the bank below the capital ratios required by regulators, thereby making Silvergate delay sending its annual report to the Securities and Exchange Commission. The bank added that it was unsure about its capacity to carry on.

When Silvergate suddenly shut down its payments network, it looked like the bank, which had once been seen as a very promising company and stock, was almost dead.

Why Silvergate Bank’s Crash Different From Other Failures in the Crypto Industry

In contrast to Luna and FTX‘s crashes, which were caused by depegging and financial mismanagement, the situation with Silvergate appears to be a genuine bank run.

After the collapse of FTX, digital asset deposits decreased significantly, prompting Silvergate to adopt policies to withstand bank runs. This included cost-cutting measures, such as reducing its workforce by around 40%, reviewing its product offerings and customer relationships, and adjusting expenses.

Despite these efforts, the management team realized their policies were insufficient to maintain deposit safety and accessibility. The team had structured their balance sheet to withstand a 70% drawdown on deposits and kept cash reserves that exceeded all remaining deposits. However, the outcome shows that these efforts were insufficient as the bank suffered from a bank run.

Similarities Between the Collapse of Silvergate Bank and Silicon Valley Bank

Both banks were hit hard by a wave of withdrawals that led them to sell securities that had been kept as reserves. These multibillion-dollar sales resulted in substantial write-downs because the value of their portfolios had decreased due to rising interest rates.

When rates go up, bond prices tend to go down, and this is what happened because the Federal Reserve has been raising interest rates in a bid to tame inflation. Consequently, this led to big losses for the banks.

The failure of these two banks has increased uncertainty in the financial sector and created a significant obstacle for the cryptocurrency business, as financial ties are essential for crypto firms to maintain their infrastructure and operations. These implications are far-reaching and are likely to persist in the future.

Potential Impacts of Silvergate Bank’s Failure on the Crypto Industry

The collapse of Silvergate Bank was a significant event for the crypto industry because it was one of the few banks in the U.S. that supported cryptocurrencies. When the news broke, the price of Bitcoin dropped by 6%, indicating that the markets were preparing for potential repercussions.

This collapse raises concerns that crypto businesses may move to less regulated banks, increasing risks for all parties involved. If they cannot find a bank willing to work with them, they might resort to one that does not adhere to the rules.

In the short term, U.S. banks are expected to start limiting their exposure to cryptocurrency clients, and some have already begun the process. Signature, another bank known for supporting cryptocurrencies, has stated that it could lose up to $10 billion in deposits from crypto businesses.

To continue operating, crypto companies may choose to work with foreign financial institutions that support cryptocurrencies, such as Bahamas Deltec, Capital Union Bank, Fidor Bank, Sygnum, SEBA, Striga, and Revolut. However, the failure of Silvergate will likely attract scrutiny from regulators, who may impose strict restrictions on banks doing business with cryptocurrency startups.

In the long run, new or existing banks capable of accommodating more crypto clients without jeopardizing their diversification may step in to fill the void left by retracting banks.

Lessons Learned From Silvergate Bank Crash

Importance of Risk Management

Silvergate Bank’s failure emphasizes how crucial risk management is to the financial sector. Good risk management is essential for averting disasters, but it also aids in decision-making, trust-building among stakeholders, and fostering a culture of awareness and accountability. So, to ensure their long-term success, financial institutions must prioritize risk management and make the necessary investments in both resources and strategy.

Need for Oversight and Accountability

Oversight and accountability are crucial to ensure that the banking sector operates securely and ethically as it benefits clients and other stakeholders. Without proper supervision and accountability, the risk increases, and the trust decreases, leading to negative impacts on the financial institution and the economy as a whole.

To prevent such situations, the industry must prioritize oversight and accountability through regulatory monitoring, risk management strategies, and transparent reporting procedures. The goal should be establishing a reliable and secure banking system that all parties can trust.

The Next Steps for Silvergate Bank

Silvergate Bank has announced its plans to liquidate its assets according to regulatory procedures while also exploring options to resolve claims and preserve the residual value of its assets.

The bank’s proprietary technology and tax assets are among the assets to be liquidated. The Silvergate Exchange Network, which facilitated the transfer of funds among financial institutions, including Kraken, Gemini, and Coinbase, has already been shut down this month.

Several companies, including Coinbase, Crypto.com, and Paxos, have begun distancing themselves from Silvergate Bank, and even Tether has done the same. The bank had few supporters, and its role in the FTX meltdown is under scrutiny by the government.

It remains to be seen how the collapse of Silvergate Bank will impact liquidity in the crypto ecosystem, given that its payments network facilitated over $1 trillion in transactions. Additionally, the bank’s collapse is likely to attract attention from lawmakers who are concerned about the spread of crypto risks to the traditional financial sector.

If you would like to read more articles like this, visit DeFi Planet and follow us on Twitter, LinkedIn, Facebook, and Instagram, and CoinMarketCap Community.