On January 3, the US Federal Reserve, Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency together warned banks that holding on their balance sheets cryptoassets that are stored or transferred on an open, public and/or decentralized blockchain was “highly likely to be inconsistent with safe and sound banking practices”.
The three lead US regulators stated their determination that “risks related to the cryptoasset sector that cannot be mitigated or controlled do not migrate to the banking system”.
Two days later, Silvergate Capital Corp revealed why regulators are so concerned. It had suffered a run on deposits, as crypto investors stopped trading after the collapse of FTX and pulled money out.
It saw 60% of its total funding simply vanish in less than two months.
Digital industry
Based in La Jolla, California and quoted on the New York Stock Exchange (NYSE), Silvergate is a Fed member bank. It has gone further than any other regulated US lender in building its business around what it calls the digital currency industry.
It provides bitcoin-collateralized loans and its Silvergate Exchange Network (SEN) is a leading infrastructure for crypto exchanges and investors to send and receive dollars and euros between each other in real time, all the time.
When the small local bank shifted into the business in 2014, it looked like fiat deposits from crypto investors and businesses might be a great source of low-cost funding for classic commercial and mortgage lending. But crypto became its main focus.
The SEN network has facilitated over $1 trillion of payments since 2017, and when crypto prices peaked in November 2021, Silvergate shares traded at $204. Today, they trade at $11.50.
At the start of November, the bank had total funding of $13.9 billion, of which fully 86% comprised deposits of customers in the crypto business. By the start of this year, those $11.9 billion of deposits had shrunk to $3.8 billion, having touched $3.5 billion at the lowest point.
Silvergate has survived a run accounting for 70% of its deposits. Bank regulators and investors should be asking how on Earth it has not collapsed
There is no way of knowing whether or when the crypto trading business will revive and those deposits will return. FTX is simply the latest episode in the unwinding of a vast over-leveraging of crypto that began last May with the collapse of Terra/Luna.
But here is the most remarkable thing about Silvergate: it has survived a run accounting for 70% of its deposits. Bank regulators and investors should be asking how on Earth it has not collapsed.
It had an emergency plan that it never wanted to use but had to expand upon. As a good, regulated bank, Silvergate held substantial amounts of both cash and high-quality and pledgeable securities to see it through a run.
In November, it first began borrowing against its holdings of US Treasuries and agency bonds. Then it began selling them, even securities previously characterized as hold-to-maturity. It incurred $718 million of realized losses in the process of selling $5.2 billion of bonds in the fourth quarter and had to take another $300 million of fair-value adjustments on a remaining portfolio that is now clearly all available for sale.
After all that, come the start of this year, it still had $4.6 billion of cash and equivalents, well in excess of its remaining digital deposits, and $5.6 billion of securities. It will have to sell more of these.
Brutal business
Silvergate’s business restructuring will be brutal. It will cut 40% of the workforce and take write-downs, notably on the assets it acquired from Diem in January 2022 and that it had hoped to launch a digital dollar on. It can no longer credibly model likely future revenues from those assets.
It must review its entire product portfolio. But one early decision is to exit mortgage warehouse lending. It remains focused on its chosen industry. And it has not lost any money or made any forced liquidations of bitcoin-backed loans, suggesting it can manage volatile collateral well.
Its main hope is that a bigger bank will buy it with a view to profiting from any resurgence in crypto. The last chapter is not written yet for the wider crypto industry or for Silvergate. It still holds $150 million of deposits from customers that have gone bankrupt.
But the rather inconvenient truth here seems to be that regulated banks may survive a crypto crash as long as they truly understand the attendant volatility and can manage the liquidity and collateral risks.
