As soon as the FTX collapse seems to have been digested to some extent, the next catastrophe for the crypto market is imminent: the Silvergate bank collapses. The California bank has handled a very large portion of dollar transactions in the ecosystem. Now these depend almost entirely on one remaining bank…
Yes, the idea of bitcoin and crypto is to become independent from banks. Bitcoin doesn’t need a bank, Ethereum doesn’t need a bank, tokens don’t need a bank, smart contracts don’t need a bank. Per se.
If crypto were to function in a vacuum, with no connections to real economies, there would be no need for banks. But because this is not the case, bitcoins and other coins are being traded wildly against dollars, and because even if the dollars are running as stablecoins on a blockchain, there is a bank holding the deposits, the ecosystem is still in enormous dependence on banks. And that’s leading to big problems behind the scenes right now.
Silvergate Bank seems to be the sick man of the crypto market right now.
From a small bank to a colossus thanks to crypto – and back again
Silvergate Capital is actually a rather small bank from California that has specialized in processing dollar payments for crypto companies such as stock exchanges since 2013. After the bank had won some of the largest exchanges as customers – such as Binance, Kraken or Gemini – it grew rapidly. It pays to work with crypto, especially when all other banks are embarrassed.
I realize some people may be wondering WTF just happened so here’s the unannotated short version…
The story begins when $SI, a small regional bank, decided to go full crypto.
— ⚯ M Cryptadamus ⚯ | @email@example.com (@Cryptadamist) March 4, 2023
Silvergate’s stock market price had exploded by the end of 2021, from once a few to almost $200. The bank held around $15 billion in deposits and processed $750 billion worth of transactions through the Silvergate Exchange Network (SEN) it founded. SEN is based on a blockchain, which is architecturally based on Facebook’s ex-project Libra .
Together with Signature Bank, Silvergate processed most of the dollar payments from crypto exchanges. The two banks had a combined transaction volume of about $1.75 trillion a year, which is 15 percent of all VISA transactions or 0.7 percent of all global bank transfers. The volume is enormous, and this mass alone should cause problems with supervision.
Now Silvergate seems to be collapsing. The stock price has fallen nearly 95 percent over the past 12 months, with the collapse accelerating over the past week. The rate has fallen from $13 to barely $5, and big customers are scrambling to get out of the bank.
One of the exciting questions of this drama is how it could have happened. Because Silvergate had a dreamlike business model: The bank kept huge sums of money in its accounts and could use it to buy safe and interest-bearing securities such as government bonds. With only 1-2 percent interest per deposit, Silvergate made many millions of dollars a year. How can you go broke here?
All the profits went to waste
The explanation is interesting: Silvergate bought US Treasuries when interest rates were historically low, when they were only yielding about 1% a year. It was even more unfavorable that the bank had bought very long-term securities, with a term of 10 years, for example.
Now it happened that the US Federal Reserve had raised interest rates, so that government bonds were bringing in around four percent interest. With that, of course, no one wants to buy the low-yielding 10-year government bonds that Silvergate has acquired. Their value on the secondary market fell to about 90 percent.
That’s not a problem in itself — if you don’t want to sell the bonds. Silvergate could have just sat it out and collected low but solid interest rates. But then FTX collapsed.
Customers wanted to withdraw their money, trust was crumbling, and Silvergate was left with no choice but to sell the Treasuries at a loss to service withdrawal requests. The bank is said to have lost about a billion dollars a month. All the profits she had made since 2013 flowed away.
Worse still, however, was that customers had lost confidence. Rumors of failure circulated, which for a bank whose product is trust is almost the same as failure itself. Customers left the bank and withdrew their deposits. A bank run ensued and the fall accelerated. Then, late last week , the bank shut down the SEN network, effectively abandoning the crypto market.
The pillar that still stands
This could become uncomfortable for the crypto industry. $750 billion in annual dollar transfers is collapsing, and almost all of the dollar flow between exchanges now goes through Signature, the surviving bank. Of course, this now enjoys a level of attention that can only be unpleasant for a bank with this business model.
Like Silvergate, Signature uses a blockchain-based network, Signet, to transfer dollars between its customers in real time. Most major bitcoin exchanges have joined Signet, which, like SEN, is built on top of Libra technology. For example Coinbase, Bittrex, FTX, Kraken, Bitstamp or Binance.
There is now an almost never-ending tide of rumored dealings Signature is said to be involved in. From saying they are Tether’s bank to allegations of money laundering or violating sanctions. Exactly what it is cannot be said at this time. However, it is becoming clear once again that Fiat transactions are the weak point of the crypto market, and that a collapse of Silvergate – and possibly also Signature as a result – would lead to considerable friction in the market at the current time.