Uh oh! The collapse of cryptocurrency has reached the real financial system

Silvergate, one of the most important banks in cryptocurrency, is in big trouble. Maybe an existential problem.

Silvergate has not started encrypting. I started in real estate. But in January 2014, the bank jumped into Bitcoin, Volatile year Bitcoin started the year at $770 and closed above $300 in December. “Some of the companies that were formed at that time to provide services to this nascent Bitcoin space, many of them were struggling to find and maintain bank accounts,” he said. Silvergate CEO Alan Lane on the June 2022 episode of a lot Podcast. “So that was really where we started.”

The focus at the bank has been on institutions — other companies, some of which work with consumers. For example, Genesis, DCG’s now-bankrupt crypto lending company, was among Silvergate’s first clients. The bank developed the Silvergate Exchange Network, which has been a way for crypto institutions like Coinbase, Gemini, and Kraken to transact in dollars 24/7. “We all have it. All the big companies. Anyone serious about regulation,” Lin said in 2022.

Lin’s clients include: FTX. Federal prosecutors are now examining Silvergate’s role Sam Bankman Fred’s collapsing banking empire. The most immediate problem is that the collapse of FTX has spooked other Silvergate customers, leading to $8.1 billion on the bank: 60 percent of its deposits got out the door in just one quarter. (“Worse than the average bank went through to close in the Great Depression,” the Wall Street Journal Helpful explanation.)

In its earnings filing, we discovered that Silvergate’s results This past quarter was absolutely violent, a loss of 1 billion dollars. Then, on March 1, Silvergate ran into a surprising regulatory filing. It says that, in fact, The results were quarterly the worstAnd It is not clear that the bank will be able to continue to operate.

in response, CoinbaseGalaxy Digital, Crypto.com, circleAnd Paxos They said they would stop using Silvergate – as he did Other clients are less known. Tether, the controversial stablecoin that has had its own problems with banks, It helpfully popped up to remind us that it wasn’t using Silvergate.

Customers’ laundry list helps explain why Silvergate is so concerned. Very few banks will deal with crypto because it’s too risky – and most traditional banks don’t allow crypto customers to transact in dollars 24/7. It is rare to have access to banking services that move at the pace of cryptocurrency, and only one US bank can do it.

“If Silvergate goes out of business, it will push funds and market makers farther out,” he said. Ava Labs President John Wu said Barron. The problem is how easy it is to access actual cash dollars, which in financial talk is called liquidity. Less liquidity makes transactions more difficult. Wu said there is already a wider gap between the price at which a trade is expected to take place and the actual price at which it is executed.

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

Silvergate’s SEN was significant highs in and out of the Great Dollar (and Great Euro) to cryptocurrencies. In 2022, Lin said, all regulated stablecoin issuers backed by US dollars are banked in Silvergate.

But for the stablecoins issued by Circle, Paxos, and Gemini, among others, SEN has been important for making and burning their tokens, which are issued when someone deposits a dollar into their Silvergate bank accounts, Lin said.

Silvergate has been a transit point for cryptocurrency. At least dollar-backed stablecoins theoretically It has cash or cash assets held in reserve somewhere. (The reason Tether is so controversial is because there are questions about the existence and value of that reserve.) Silvergate’s job was to generate a token when someone puts a dollar into USDC, for example, and burn a token when someone takes out a dollar. “We are an important part of the infrastructure where people are coming out of the ecosystem and they want to go to cash — these dollars are going through Silvergate,” Lin said in 2022.

You’ll notice I say “was”. That’s because on March 3, Silvergate has announced that it will be suspending SENeffective immediately.

The dollar side of the deal meant that Silvergate customers had to keep a pool of cash on hand in the bank in order to pay each other and anyone who wanted to cash out. To make money here, Silvergate can do a few things. The safest thing is to buy a one-month Treasury note from the Federal Reserve and call it a day.

Now, this being financing, risk can also mean more profit. So it looks like Silvergate has bought the bonds. (edge Favorite Matt Levine bloomberg He has a more in depth analysis of how this works If you want gory details.) The problem isn’t that the bonds were too risky — it’s that FTX sparked an exodus of dollars, and Silvergate suddenly had to come up with a bunch of cash. Unfortunately, that meant selling its bonds at a loss in order to pay off its obligations. Ironically, the bonds were pretty safe — “If depositors had kept their money in Silvergate, her bonds would have matured with plenty of money to pay back,” notes Levine.

Silvergate has another way to touch stablecoins besides serving as an in-and-out platform for its transactions. It bought assets from the doomed Libra coin, later renamed Diem, in January 2022. At that time, Silvergate said it would start Diem made available by the end of the year. The goal was a digital payments network.

One of the other services provided by Silvergate was The ability to lend dollars in exchange for bitcoin. Now, Silvergate he said in January In its fourth-quarter earnings announcement, “all SEN leveraged loans continued to perform as expected, with no losses or forced liquidations.” These loans may be good! Silvergate doesn’t seem to have done anything exceptionally risky anywhere else.

But if you want to use Bitcoin to get a dollar loan, I think it is much more difficult.

Silvergate lived before cryptocurrencyIt was a small bank focused on real estate deals in Southern California. During that period, she had never had more than $1 billion in deposits, according to her Financial Times. And Silvergate needed a deposit. When Lin led the company into crypto, its business swelled. By 2021, Silvergate will have more than $10 billion in net worth. the The bank went public in 2019 at $12 a share and peaked at over $200 a share in 2021. (Shares closed at $5.77 on March 3).

The focus on real estate is becoming less and less because cryptocurrency has been a rocket ship for the bank. But that real estate tie-up proved beneficial for Silvergate in 2022. In the last quarter of the year, Silvergate has secured at least $3.6 billion in funds from federal home loan banksa 1930s-era system that also originally dealt in mortgages.

To pay it off, Silvergate sold more bonds. This isn’t ideal, which is part of the reason Silvergate is in trouble. “If you’re a bank, you don’t want to point in the wrong direction, because that becomes self-fulfilling,” he says. He writes bloombergLevin. Indeed, this is why so many major Silvergate customers are dismayed. Levine thinks this could spark some regulators’ interest in crypto banking.

In fact, the Department of Justice is already interested. There are some questions about the strange transactions that took place at Silvergate.

For example, Binance. Its standalone arm, Binance.US, has funneled more than $400 million into a trading company called Merit Peak Ltd, Reuters mentioned. This company is managed by Binance CEO Changpeng Zhao. Binance.US CEO at the time, Kathryn Cooley, wrote to one of Binance’s CFOs in late 2020 seeking clarification of the transfers, describing them as “unexpected” and saying “no one mentioned them.” Reuters books. These transmissions took place on Silvergate’s SEN network.

This is similar to some of the problems Silvergate has around FTX. Alameda Research, a trading company also owned by Bankman-Fried, opened an account with Silvergate in 2018. Bankman-Fried admitted that it used Alameda accounts for FTX funds, combining client funds with the company’s trading funds.

I don’t know if Silvergate did anything wrong. Maybe not! But getting the feds to start digging, asking questions? This is a headache and distraction. It’s the last thing a struggling bank needs.

A lot of the companies that have done business with Silvergate Bank here have talked about how minimal exposure they have been, a history that isn’t a great sign. (be seen: Bankman-Fried’s infamous “FTX is good. Assets are good” tweet.)

But did you know? In this particular case, I’m inclined to believe them. First of all, Silvergate has already left a load of money behind. But secondly, SIlvergate was a pass-through cryptocurrency bank. It did not keep its reserves and did not pay interest. The problem here is that some exchanges or stablecoins will suffer a huge loss of customer funds and more than they are now. It is difficult for crypto companies to obtain banking services.

The cryptocurrency industry desperately needs banks. But both Silvergate’s competitors, Metropolitan and Signature, were pulling back from the sector even before this debacle. Metropolitan said in January that it was Exit cryptocurrency. And in December, Signature said it was going for it Disposing of $8 billion to $10 billion in digital asset-related funds.

I don’t know if Silvergate will ever come through with this. But I highly doubt that it has become very difficult to get dollars from cryptocurrency and from cryptocurrency to dollars. Silvergate dealt in liquidity, and a The problem of liquidity can become a problem of solvency Really fast. The entire crypto industry is becoming more fragile.