When mainstream banks were closing traders' accounts, Silvergate embraced cryptocurrency exchanges. Now it's gone and no mainstream banks want to take its place.
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When a publicly traded bank announces that it is reviewing whether it is able to continue as a going concern, the answer is likely to be "no."
Just having to ask the question in a Securities and Exchange Commission filing is generally enough to provide the answer.
So it proved for Silvergate, the longest-standing and most important bank serving the crypto industry.
The institution has announced that its closing its doors — badly bruised after that fateful filing led to an exodus of major corporate clients… Coinbase, Gemini, Paxos and Circle among them.
"An orderly wind down of bank operations and a voluntary liquidation of the bank is the best path forward," the California-based corporation said in a statement. This would include repayment of all deposits, it added.
SIlvergate blamed "recent industry and regulatory developments" for its woes.
Those regulatory developments covered a host of issues, from a Justice Department investigation to growing moves by the Federal Reserve and other federal agencies with oversight of the banking industry pushing those institutions far away from crypto.
FTX Does Fatal Damage
By "recent industry developments" Silvergate meant the collapse of Sam Bankman-Fried's FTX exchange empire in an alleged $10 billion fraud.
While it had ties to other troubled crypto institutions — bankrupt lender Genesis was an early client — the collapse of FTX proved the undoing of Silvergate.
Both FTX and Bankman-Fried's private trading firm Alameda Research were Silvergate customers from their beginnings, and the misappropriation of funds between the two firms led the Justice Department to announce an investigation into the bank's role in their collapse on Feb. 2. Silvergate's shares dropped 20% that day.
While no actual wrongdoing by Silvergate had been alleged, the illicit movement of FTX customer funds to Alameda, where they were traded and lost — three top executives have pleaded guilty and will testify against Bankman-Fried — raised questions about the bank's role, as well as its oversight of and due diligence with its client.
Among other things, a Silvergate account belonging to Alameda was used by FTX customers to onramp exchange funds, beginning the commingling that would become a key part of the scheme to allow Alameda to draw on the resources of FTX's customers.
In the wake of a near-run following FTX's collapse, Silvergate revealed a fourth-quarter 2022 loss of $1 billion, as well as borrowing $4.3 billion from a little-known federal agency, the Federal Home Loan Bank (FHLB) system. Its deposits from institutional crypto clients dropped from $11.9 billion at the end of Q3 to $3.8 billion in Q4, down 68%.
Why Silvergate Mattered
In many ways, Silvergate's collapse has left nearly as big a hole in the U.S. cryptocurrency industry as FTX's did.
Without Silvergate, a number of crypto exchanges — Crypto.com among them — are struggling to figure out how to allow customers to move dollars into their trading accounts and off-ramp them into their bank accounts.
That's not their only trouble. The bank's Silvergate Exchange Network (SEN) was a primary way for those and other big crypto firms to move dollars between themselves 24/7, rather than according to the traditional banking industry's far more subscribed hours.
Silvergate was a tiny real estate-focused bank in 2014, when it saw a big opportunity in crypto that most other banks were unwilling to touch. While mainstream banks were still closing retail customers accounts if they were caught moving money onto or off of cryptocurrency exchanges, Silvergate jumped in.
For many crypto companies, SIlvergate was one of if not the only dollar on and off-ramps available.
As recently as 2019, Barclays dumped Coinbase as a client, while Wells Fargo booted Bitfinex a year earlier. Bank of America, JPMorgan Chase and Citigroup stopped allowing credit card purchase of bitcoin as far back as 2018.
The best example of the trouble this caused was the Wells Fargo cutoff of Bitfinex, which was hit so hard that it turned to Panamanian payments processor Crypto Capital Corp (CCC) to get dollars to and from its U.S. clients. That was something federal prosecutors have said CCC accomplished by opening bank accounts it claimed were for real estate transactions.
That led to a crisis after some $850 million of Bitfinex's funds were seized by U.S. and European governments, which said Crypto Capital was involved in other shady businesses. Bitfinex was forced to borrow heavily from sister company Tether, causing the stablecoin issuer serious problems with regulators.
Other Choices
While banks started embracing crypto themselves in 2020 and especially during the bull market of 2021, getting them to actually take on exchanges and other crypto firms as clients remained difficult.
For a while, Silvergate prospered. Its shares grew from $12 when it went public in November 2019 to nearly $220 at the height of the crypto bull market two years later. It was at about $50 before FTX collapsed in November 2022 and closed at $2.84 on Thursday.
Still, there were other options. New York's Metropolitan Commercial Bank and Signature Bank also chased the market.
The Kraken exchange and fledgling crypto bank Custodia — formerly Avanti — were the first to gain state-issued charters via a special program in Wyoming, while crypto custodian Anchorage, stablecoin issuer Paxos and Seattle-based Protego Trust Bank all received conditional approval of national trust charters from the Treasury Department's bank regulator, the Office of the Comptroller of the Currency in 2021. Of course, that conditional approval hasn't been made permanent.
However, that's when it was run by Brian Brooks, whose previous job had been chief legal officer of Coinbase. He pushed banks towards embracing crypto customers.
The Feds Say No
That changed with the Biden administration's appointee, Acting Comptroller of the Currency Michael Hsu, who walked back all of Brooks' pro-crypto moves.
The big regulatory pushback came on Jan. 3, when the Federal Reserve, OCC and Federal Deposit Insurance Corporation (FDIC) issued a joint statement on Crypto-Asset Risks to Banking Organizations.
After a lengthy list of the risks, volatility, numerous frauds and hacks, and especially the "systemic risk" that crypto asset troubles could spill over into the mainstream financial system, the three banking oversight agencies warned:
"The agencies continue to take a careful and cautious approach related to current or proposed crypto-asset-related activities and exposures at each banking organization."
Which sounds reasonable. As does the next sentence noting that banks "are neither prohibited nor discouraged" from providing services to any type of business.
Then comes the meat of the document. While noting that the three agencies "are continuing to assess" how banks can work with crypto clients in a safe and compliant manner, it said:
"Based on the agencies' current understanding and experience to date, the agencies believe that issuing or holding as principal crypto-assets… is highly likely to be inconsistent with safe and sound banking practices. Further, the agencies have significant safety and soundness concerns with business models that are concentrated in crypto-asset-related activities or have concentrated exposures to the crypto-asset sector."
It then went on to warn them to "ensure that crypto-asset-related activities can be performed in a safe and sound manner."
Which is about as subtle as a punch in the face.
Walking Away
On March 8, Reuters reported that JPMorgan Chase is cutting ties with New York-based and regulated exchange Gemini, although the exchange said that was not true. In February, the Wall Street Journal cited examples of Citigroup and First Republic cutting ties or refusing to do business with crypto-related companies.
Other small, crypto-friendly banks are backing away, too.
Metropolitan Commercial Bank announced it was getting out of the crypto business altogether in January, and Signature Bank started pairing back crypto clients in February,
However, when they did, both had other lines of business to fall back on. That's something Silvergate did not have.
Why Silvergate Failed
There's an argument to be made that Silvergate's failure was not due to the risks or dangers of the crypto industry as much as its failure to follow some very basic good banking practices.
For one thing, it's noteworthy that Silvergate's clients won't — it says — lose anything as it shuts down. That's because its assets weren't loaned out like many banks do with their depositors' funds, or invested in risky cryptocurrencies or derivative bets like many of the crypto lenders that went belly up.
But, its business was concentrated in one sector, so that when crypto went sideways, Silvergate had nothing else to fall back on.
For another, Silvergate's assets were in cash and very solid assets like U.S. Treasuries and securitized residential mortgage loans — bonds — backed and issued by U.S. agencies. But, the bank did not account for what's called interest rate risk.
When the Fed began aggressively hiking interest rates last year those very solid assets nonetheless declined in value. Which isn't a problem if Silvergate could have held onto them until they matured.
But in Q4 2022, it could not wait. Faced with $8.1 billion in withdrawals that quarter, Silvergate had to sell its very solid securities at a steep loss: $718 million.
"Silvergate's troubles are as much if not more about traditional banking risks — lack of diversification, maturity mismatches — as it is about its exposure to crypto," Sheila Bair, who led the FDIC during the 2008-2009 global financial crisis, told Bloomberg.
Paying the Price
Not everyone sees it that way.
"Today we are seeing what can happen when a bank is overreliant on a risky, volatile sector like cryptocurrencies," said Senate Banking Committee Chairman Sherrod Brown, an Ohio Democrat. He added:
"I've been concerned that when banks get involved with crypto, it spreads risk across the financial system and it will be taxpayers and consumers who pay the price."
Of course, Silvergate says none of its depositors or the taxpayers will pay a price.
However, without more banking alternatives — and a number of states have followed Wyoming's lead in pushing for state-issued crypto banking charters like Kraken's — the alternative could well be a return to non-bank payments processors. Which doesn't always end well.
