Oh oh ! The Crypto Collapse Has Hit the Real Financial System

Silvergate, one of the most prominent crypto banks, is in deep trouble. Maybe an existential problem.

Silvergate didn’t start out in crypto. It all started in real estate. But in January 2014, the bank jumped on bitcoin, a volatile year – bitcoin started the year at $770 and closed above $300 in December. “Some of the companies that were forming at the time to provide services to this budding bitcoin space, many of them were struggling to find and maintain bank accounts,” Silvergate CEO Alan Lane said. in a June 2022 episode of odd lots podcast. “So that’s really where we started.”

“We got them all,” Lane said in 2022. “All the majors.”

The bank focused on institutions – other businesses, some of which work with consumers. For example, Genesis, DCG’s bankrupt crypto-lending subsidiary, was among Silvergate’s first customers. The bank developed the Silvergate Exchange Network, which was 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 majors. Anyone who’s serious about regulation.

Also among Lane’s clients: FTX. Federal prosecutors are currently investigating Silvergate’s role in Sam Bankman-Fried’s fallen empire banking. The more pressing issue is that FTX’s collapse spooked other Silvergate customers, leading to an $8.1 billion run on the bank: 60% of its deposits disappeared in a single quarter. (“Worse than that experienced by the average bank to close during the Great Depression,” THE the wall street journal helpfully explained.)

In its earnings filing, we found that Silvergate’s results last quarter were absolute crap, a $1 billion loss. Then, on March 1, Silvergate filed a surprise regulatory filing. He says that in fact the quarterly results were even worseand it is unclear whether the bank will be able to remain in business.

In response, CoinbaseDigital Galaxy, Crypto.com, CircleAnd Paxos said they would stop using Silvergate – as did other less notable customers. Tether, the controversial stablecoin that has had its own issues with banking, popped up helpfully to remind us that he wasn’t using Silvergate.

“If Silvergate goes bankrupt, it will push funds and market makers further overseas.”

The long list of clients helps explain why Silvergate’s woes are frightening. Very few banks will dabble in crypto because it’s so risky – and most traditional banks don’t let crypto customers do dollar transactions 24/7. Access to banking services that keep pace with crypto is rare, and only another US bank can do it.

“If Silvergate goes bankrupt, it’s going to push funds and market makers further overseas,” Ava Labs chairman John Wu said. Barrons. The problem is how easy it is to get real money, which in financial parlance is called liquidity. Less liquidity makes transactions more difficult. There is already a wider gap between the price at which a trade is supposed to take place and the actual price at which it executes, Wu said.

Silvergate’s problems are therefore a problem for the entire crypto industry.

Silvergate’s SEN was an important on and off ramp from the almighty dollar (and almighty euro) into crypto. In 2022, Lane said that all “US dollar-regulated and backed stablecoin issuers” were banking at Silvergate.

But for stablecoins issued by Circle, Paxos and Gemini, among others, the SEN was important for making and burning their tokens, which were issued when someone deposited a dollar in their Silvergate bank account, Lane said.

“We are that critical piece of infrastructure.”

Silvergate was a gateway for crypto. Stablecoins that are backed by dollars at least theoretically have cash or cash-like assets in reserve somewhere. (The reason Tether is controversial is that there are questions about the existence and value of this reserve.) Silvergate’s job was to create a token when someone put a dollar in, say, the USDC and burn a token when someone withdraws one. “We are this critical infrastructure where people, as they leave the ecosystem and want to go get money, those dollars go through Silvergate,” Lane said in 2022.

You will notice that I say “was”. Indeed, on March 3, Silvergate announced that it was suspending SEN, effective immediately.

The dollar side of the transaction meant that Silvergate customers had to keep a lot of cash on hand in the bank in order to pay themselves and anyone who wanted to cash out. To make money here, Silvergate could do a few things. The safest thing to do is to buy, for example, one-month Treasury bills at the Fed and stop there.

Now, this being finance, taking on more risk can also mean more profit. Silvergate therefore seems to have bought bonds. (Edge Matt Levine preferred to Bloomberg has a more in-depth analysis of how it worked if you want the gory details.) The problem isn’t that the bonds were super risky – it’s that FTX triggered a massive dollar exodus, and Silvergate suddenly had to offer a lot of money. Unfortunately, that meant selling his bonds at a loss in order to pay his obligations. Ironically, the bonds were quite safe – “if its depositors had kept their money at Silvergate, its bonds would have matured with plenty of money to pay them back,” notes Levine.

Silvergate has another way to touch stablecoins besides acting as an on- and off-ramp for their transactions. It bought assets from Facebook’s doomed attempt Libra, later renamed Diem, in January 2022. At the time, Silvergate said it would start making Diem available by the end of the month. ‘year. The goal was a digital payment network.

One of the other services offered by Silvergate was the ability to lend dollars against Bitcoin. Now, Silvergate said in its January fourth quarter earnings call that “all of our SEN leveraged loans continued to operate as planned with no losses or forced liquidations.” Maybe these loans are good! Silvergate doesn’t appear to have done anything exceptionally risky elsewhere.

But if you want to use your bitcoin to take out a dollar loan, I think that becomes more difficult.

Silvergate had a life before crypto: it was a small bank focused on real estate transactions in Southern California. During that time, he never had more than $1 billion in deposits, according to The Financial Times. And Silvergate needed deposits. When Lane steered the company into crypto, its business skyrocketed. In 2021, Silvergate had over $10 billion. The bank went public in 2019 at $12 per share and peaked at over $200 per share in 2021. (The shares closed at $5.77 on March 3.)

Real estate became less and less of a priority because crypto was a rocket ship for the bank. But that real estate connection has come in handy for Silvergate in 2022, however. In the last quarter of the year, Silvergate secured at least $3.6 billion in funds from the Federal Home Loan Banks, a 1930s system that also originally handled mortgages.

To repay this, Silvergate sold more bonds. That’s not ideal, and that’s part of the reason Silvergate is in trouble. “If you’re a bank, you don’t want to point in the wrong direction because it becomes self-fulfilling,” writes Bloombergit’s Levine. And indeed, that’s why many major Silvergate customers are scared off. Levine thinks this might interest some regulators in crypto banking.

In fact, the Department of Justice is already interested. There are a few questions about the bizarre dealings that took place at Silvergate.

For example, Binance. Its supposedly independent arm, Binance.US, transferred over $400 million to a trading company called Merit Peak Ltd, Reuters reported. This company is led by Binance CEO Changpeng Zhao. “The CEO of Binance.US at the time, Catherine Coley, wrote to a Binance CFO in late 2020 asking for an explanation of the transfers, calling them ‘unexpected’ and saying ‘nobody mentioned them'” . Reuters writing. These transfers took place on the special network of Silvergate, 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 funds with those of the trading company. .

I don’t know if Silvergate did anything wrong. Maybe not! But that the feds start snooping around, asking questions? It’s a headache and a distraction. It’s the last thing a troubled bank needs.

Many companies that have done business with Silvergate have spoken here about how little exposure they have to it, which historically isn’t a good sign. (See: Bankman-Fried’s infamous “FTX doing well. Assets doing well” tweet.)

But you know what? In this specific case, I tend to believe them. First of all, just fucking money has already left Silvergate. But second, SIlvergate was a bridge bank for crypto; it held no reserves and paid no interest. The issue here is less that some exchanges or stablecoins are going to suffer a massive loss of customer money and more that it is now even more difficult for crypto companies to obtain banking services.

The crypto industry desperately needs banks. But Silvergate’s two competitors, Metropolitan and Signature, were pulling out of the business even before this debacle. Metropolitan said in January that it was getting out of crypto altogether. And in December, Signature announced it was getting rid of $8 billion to $10 billion in funds tied to digital assets.

I don’t know if Silvergate will make it. But I strongly suspect that it has become much harder to get in dollars from crypto and get out of crypto in dollars. Silvergate was trading cash, and a liquidity problem can become a solvency problem very quickly. The entire crypto industry has become much more fragile.

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