Why silvergate’s post-ftx financial woes could spell trouble ahead for crypto

Crypto's darkest days and biggest barriers to growth have stemmed from startups' inability to secure banking relationships. With Silvergate Capital struggling for survival, many in

crypto are worried the industry may be suffering a big and familiar setback: the industry is being de-risked from the banking system. Further, the spillover into a traditional bank and its

stock price could fuel regulators' arguments that crypto poses a systemic risk. "Up until now we've been able to say that the fallout of everything that happened last year was

contained within the crypto industry – painful, but contained," said Noelle Acheson, economist and author of the Crypto is Macro Now newsletter. "If Silvergate goes under then the

regulators will be able to say 'aha, systemic risk, we told you so.' That will give them even more ammunition to go after crypto and increase their choke on fiat access for crypto

businesses." Shares of Silvergate, a famously crypto-friendly bank, plummeted 60% last week after the company delayed the filing of its annual report, citing financial challenges

associated with the downfall of its former customer FTX — specifically, the "sale of additional investment securities beyond what was previously anticipated." Silvergate has come

under increased regulatory scrutiny since the collapse of FTX. In February, Senators Elizabeth Warren (D-Mass.), John Kennedy (R-La.), and Roger Marshall (R-Kan.) penned a letter to CEO Alan

Lane accusing the bank of "further introducing crypto market risk into the traditional banking system" through its business relationship with FTX and its since-indicted CEO Sam

Bankman-Fried. The next day the Department of Justice said it's probing the bank's dealings with FTX and its sister company Alameda Research. Crypto's 'dark ages'

Silvergate didn't get its start as the "crypto bank" it is now, but it saw the opportunity early to service reputable crypto companies and has become a lifeline for U.S.

crypto startups. The big problem in crypto is that to buy bitcoin, you eventually have to interact with the traditional banking system. Silvergate helped solve this problem by creating easy

banking services for crypto companies, which pretty much always struggled to find banking partners. In the past decade, Silvergate has became the go-to bank for cryptocurrency companies.

"Crypto entities need banking," Acheson said. "However 'crypto' you may be, you need to pay salaries, you need to pay electricity bills, and hosting fees, etc."

"The lack of banking in the crypto industry before Silvergate and Signature came along was one of the biggest barriers to progress," she added. "It ended with many entities

opening accounts in fairly dubious entities offshore." For example, Tether, the stablecoin giant, and its sister company Bitfinex famously struggled to maintain access to global banking

system in 2018. The Wall Street Journal published an investigation Friday with new details on how the company used falsified documents and turned to shadowy intermediaries to continue.

Silvergate's crypto bet worked for the bank, particularly in bull markets. The company reported about $7 billion in deposits at the end of the first quarter of 2021. That doubled by the

end of the year, according to Silvergate's financial statements. At the end of 2019, and the end of the last crypto winter, the company held just $1.2 billion in deposits. A big part

of Silvergate's crypto banking efforts was the Silvergate Exchange Network, better known as SEN, a platform that institutions used to move money to crypto exchanges. Silvergate shut it

down late Friday, but the bank's deposit products remain operational. "Pretty much everyone in the crypto industry at one stage has used Silvergate," Acheson said, adding that

it was not just because it was crypto friendly, but also because it was "a reputable and regulated financial institution that would help them interact with the fiat economy."

Restricted access The problems at Silvergate exacerbate the regulatory hostility the crypto industry is up against. Investors were spooked last month after what appeared to be the beginning

of a regulatory crackdown on U.S. crypto businesses — including the Securities and Exchange Commission's enforcement action against Kraken , its Wells Notice of a future settlement

against Paxos and the New York State Department of Financial Services' ordering Paxos to stop minting the Binance USD (BUSD) stablecoin. Coinbase suspended transfers to and from

Silvergate last week and said it will work with Signature Bank, another well-established bank servicing the crypto industry, going forward. Silvergate's SEN handled $162 billion and

$219 billion, respectively, of transaction volume in the third and fourth quarters of 2021, according to the companies' financial statements. In the same period, Signature's answer

to SEN, Signet, handled $127 billion in the third quarter and $213 billon in the fourth. Still, while crypto has Signature as an option, there's a dark cloud hanging over it.

"They are probably thinking along the same lines as many other banks to try to peddle back their crypto exposure because it's just not worth it," Acheson said of Signature.

"The profits they make from the industry are probably not going to be compensated by the additional compliance costs and lawyer fees that they would have to incur." "Every

bank will do anything to avoid regulatory inspection – it's one of the worst things that can happen to you because it's expensive and impacts share price," she added. "If

a bank thinks that the regulators will pay extra attention to them if they happen to serve crypto companies; ... nobody wants that kind of attention." SI 1Y mountain Silvergate, 1 year

Silvergate's stock has suffered multiple drops in 2023 alone. Before its single-day 57% drop last week, it tumbled 29% the day the DOJ investigation was reported and before that, 42%

in January after it disclosed massive fourth-quarter withdrawals . The stock is down about 94% in the past year. The 2021 bubble Coinbase wasn't the only one that suspended its

relationship with Silvergate. Galaxy Digital, Circle, Paxos, Bitstamp and others did as well. It shows how much risk appetite came into crypto in the 2021 bull run, after years of investors

shunning the asset class, according to Caitlin Long, CEO of Custodia Bank. Custodia is a Wyoming-chartered special purpose depository institution designed to bridge the crypto and

traditional banking systems. It was the "tip of the spear" on the current de-banking wave, Long told CNBC. Earlier this year its application to become a member institution of the

Federal Reserve was denied. "The bank runs that have occurred prove the obvious: there's incompatibility between the traditional 'borrow short and lend long' business

model of fractional-reserve banks and fast-settling digital assets, because the bank's demand deposits can literally all be withdrawn within the span of hours. So, a bank that lends

those fast-moving deposits may not survive a bank run," she said. "Until a couple of years ago, the banks serving the crypto industry understood this risk and held 100% cash to

back demand deposits from crypto depositors, but during the 2021-22 bubble it seems a few of the banks started to take undue risks and oh boy are they paying for it now," Long said.