Crypto’s favorite bank is on the brink. What happens if Silvergate fails?

Following FTX’s collapse in November, experts warned of the contagion or systemic damage that the failure of the crypto exchange could have on the wider industry. The biggest loser after FTX itself might be Silvergate, the California-based bank that has established itself as the financial backbone of the crypto industry.

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Banks depend on customer deposits, which fell when Silvergate’s central customer, FTX, went bankrupt and crypto companies faced a steep bear market. At the time of FTX’s collapse, around 90% of the bank’s deposit base came from crypto companies. He felt the effect immediately, with the bank experiencing outflows of $8.1 billion in digital asset deposits in the fourth quarter of 2022 alone. At the end of December, its total deposits stood at around $6 billion. dollars.

Although CEO Alan Lane insisted that the bank’s mission had not changed, the writing was on the wall for Silvergate’s crypto-centric approach. Its stock price has fallen nearly 95% since mid-August, currently hovering around $6, and US senators have begun to inquire about Silvergate’s relationship with FTX.

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The bottom fell on Wednesday when Silvergate announced it would not be able to file its annual report with the Securities and Exchange Commission on time, citing the need to reassess its business strategy and “its ability to continue.”

After crypto companies turned to the bank for years as one of the only financial partners serving the volatile industry, some of the biggest companies in the industry have announced they are downscaling or severing relationships, including Coinbase, Paxos, Circle and .

Onlookers have speculated that the Federal Deposit Insurance Corporation will place Silvergate in receivership as early as Friday, beginning the process of finding another bank to acquire Silvergate or take over its deposits. A source in the crypto banking field said Fortune Wells Fargo is rumored to be the acquirer.

“Silvergate is truly a cautionary tale,” said Joseph Silvia, a former attorney at the Federal Reserve Bank of Chicago and partner at Dickinson Wright. “But there are still opportunities there, and I still don’t think cryptocurrency is generally going anywhere.”

“You can hardly do anything”

Seen by many traditional institutions as renegades, crypto companies often struggled to find banking partners – somewhat understandably for self-proclaimed disruptive companies – but they still needed traditional banking services for their salaries and their growing customers, and accounts to keep their cash flow.

While many banks were nervous, Silvergate jumped at the chance, riding the wave of the historic crypto bull market. Its share price increased by more than 1,500% between November 2019 and November 2021, with Silvergate serving more than 1,500 digital asset and fintech companies by the end of 2022.

Its share price began to wobble with the onset of the crypto bear market following the collapse of TerraUSD in May 2022, and the bankruptcy of industry giant FTX exacerbated this – crypto companies no longer had money to deposit with Silvergate.

As Silvia explained, deposits are the lifeblood of a bank. “Once it starts to deteriorate, and deteriorates that quickly, there’s almost nothing you can do to stop the bleeding,” he said.

With its share price plummeting, Silvergate could also no longer rely on the capital markets for funding, leading to its SEC filing on Wednesday in which the bank said it was “less than well capitalized”.

John Popeo, a former FDIC attorney, analyst at the Federal Reserve Bank of Boston and current partner at the Gallatin Group, said banks can fail to reach critical capital levels or depositor outflow.

If Silvergate fails to meet certain capital requirements, it will receive a Notice of Corrective Action from the FDIC and its chartering authority, or the California Department of Financial Protection and Innovation. Silvergate would then have 90 days to raise capital or sell to another bank.

In the event of more immediate financial difficulties, the FDIC could take over at any time, usually on a Friday evening, to minimize disruption to the broader financial system. In this scenario, the FDIC may be looking for a buyer now. Although Wells Fargo is rumored to be a contender, Popeo warned that onlookers without direct knowledge are ill-equipped to speculate.

As of Saturday, Silvergate is still in operation, although it announced on Friday evening that it would discontinue the Silvergate Exchange Network, a crypto-payment solution between different companies. Even though other deposit-related services remained operational, share prices fell about 2% in after-hours trading.

A shrinking universe

Crypto companies have already started shunning Silvergate, but the downstream effects may be just beginning. Silvia said Silvergate’s exit from the crypto ecosystem — and other banks’ growing reluctance to work with the industry — will make it harder for crypto businesses to get deposit accounts and other services. reviews. As a result, banking services will become more expensive for crypto companies as they explore other options, from credit unions to other types of fintech companies.

“It narrows down the universe of potential partners very quickly,” he said.

Some crypto industry players have pointed the finger at banking regulators, who issued a number of statements in the wake of FTX’s collapse warning of crypto-related liquidity risks. Nic Carter, a crypto-focused venture capitalist, described the seemingly coordinated effort by different federal regulators to deny banking services to crypto companies as “Operation Chokepoint 2.0,” a term that has since caught on. .

Silvergate’s failure, Silvia added, has a lot more to do with FTX than regulators. “There’s just a lot of trouble that banks see, without much reward,” he said. Fortune.

Even the other US bank that has established itself as crypto-friendly, Signature, has been more reluctant to work with the industry. In December, he announced that he would reduce his cryptocurrency-related deposits.

“We’re not just a crypto bank, and we want to make that crystal clear,” CEO Joe DePaolo told an investor conference.

Despite the setback in the traditional financial sector, Silvia expressed her optimism that crypto will survive, just with fewer companies. And these survivors will always need banking services.

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