Oh da! The crypto collapse has reached the real financial system

Silvergate, one of crypto’s most prominent banks, is in deep trouble. Could be an existential problem.

Silvergate didn’t start out in crypto. It started in real estate. But in January 2014, the bank jumped into Bitcoin, A fickle year – Bitcoin started the year at $770 and closed above $300 in December. “Some of the companies that were created at the time to provide services to this growing bitcoin space, many of them struggled to find and maintain bank accounts,” he said. Silvergate CEO Alan Lane in the June 2022 episode A lot of odd Internet. “So that’s where we started.”

Companies focused on banking – other companies that work with some consumers. DCG’s now-defunct crypto-lending subsidiary Genesis, for example, was one of Silvergate’s earliest customers. The bank created the Silvergate exchange network, a way for crypto companies like Coinbase, Gemini and Kraken to transact in dollars 24/7. By 2022 “we’ve got everything,” Lane said. Anyone serious about discipline.”

Among Lane’s clients: FTX. Federal prosecutors are now investigating Silvergate’s role Sam Bankman-Fried’s Fallen Empire in Banking. FTX’s decline scared off other Silvergate customers, as a result $8.1 billion flow into the bank: 60 percent of its deposits were withdrawn in just one quarter. (“Worse than the average bank experience of closing in the Great Recession” The Wall Street Journal (helpfully explained.)

In its earnings filing, we found Silvergate’s results Last quarter there were absolute dogs, a loss of $1 billion. Then, on March 1, Silvergate filed a surprise regulatory filing. It says, in fact, that the There were quarterly results Even worseAnd It is not clear that the bank can stay in business.

In response, CoinbaseGalaxy Digital, Crypto.com, CircleAnd Boxus They have said they will stop using Silvergate Other, less significant customers. Tether, the controversial stablecoin, has its own problems with banking. It helpfully pops up to remind you not to use Silvergate.

A laundry list of customers helps explain why Silvergate’s woes are frightening. Few banks will touch crypto because it’s too risky — and most traditional banks won’t allow crypto customers to transact in dollars 24/7. Access to a bank that moves at crypto speed is rare, and only an American bank can do it.

“If Silvergate goes out of business, it will push financial and market makers further offshore” Ava Labs President John Wu said Baron’s. The issue is how easy it is to move into actual cash dollars, which in financial parlance is called liquidity. Low liquidity makes transactions more difficult. There is already a wide gap between a trade’s expected price and the actual price it executes, Wu said.

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

Silvergate’s SEN is an important on- and off-ramp in crypto from the almighty dollar (and the almighty euro). By 2022, Lane said, all “regulated, US dollar-backed stablecoin issuers” will be banking on Silvergate.

But for stablecoins issued by Circle, Paxos, and Gemini, Lane said, SEN was critical to creating and burning their tokens, which were issued when someone deposited a dollar into their Silvergate bank accounts.

Silvergate is a pass-through point for crypto. Stablecoins are at least backed by dollars Theoretically Assets such as cash or cash are stored somewhere. (The reason Tether is controversial is that there are questions about that reserve balance and value.) Silvergate’s job is to create a token when someone puts a dollar into USTC, and burn the token when someone takes a dollar out. “People who want to get out of the ecosystem and into cash, those dollars go through Silvergate,” Lane said in 2022.

You’ll notice I say “was.” Because on March 3rd, Silvergate announced the suspension of SENEffective immediately.

The dollar side of the transaction means Silvergate’s customers have to keep a bunch of cash in the bank to pay each other and anyone who wants to withdraw money. Silvergate can do a few things to make money here. It’s safe to buy one-month Treasury bills at the central bank and call it a day.

Now, since this is finance, taking more risk means more profit. So it looks like Silvergate bought the bonds. (edge Favorite Matt Levine Bloomberg Here’s an in-depth analysis of how it worked (If you want the gory details.) The problem wasn’t that the bonds were too risky — FTX triggered a massive outflow in dollars, and Silvergate suddenly had to come up with a bunch of cash. Unfortunately, it sold its bonds at a loss to pay off its liabilities. Ironically, the bonds were very safe—”If its depositors had kept their money in Silvergate, its bonds would have matured with plenty of cash to repay,” notes Levine.

Apart from serving as an on- and off-ramp for their transactions, Silvergate also has another way to touch stablecoins. In January 2022 Facebook bought assets from Libra, the defunct stablecoin venture that was later renamed Time. At the time, Silvergate said it would begin. Diem will be available by the end of the year. Target is a digital payment network.

One of the other services offered by Silvergate Ability to lend dollars against Bitcoin. Now, Silvergate said in January Its fourth-quarter earnings call says “all of our SEN leveraged loans continued to perform as expected, with no losses or forced liquidations.” Maybe these loans are good! Silvergate doesn’t seem to have done anything exceptionally dangerous elsewhere.

But if you want to use your bitcoin to take out a dollar loan, I think it just got harder.

Silvergate had a life before crypto: This is a small bank focused on real estate deals in Southern California. At that time, it had no more than $1 billion in deposits The Financial Times. And Silvergate requires a deposit. As Lane led the company into crypto, its business took off. By 2021, Silvergate was worth more than $10 billion. The The bank went public in 2019 $12 per share and rises to $200 per share in 2021. (Shares closed at $5.77 on March 3.)

Real estate has been less of a focus as crypto has been a rocket ship for banking. But that real estate connection came in handy for Silvergate in 2022. In the last quarter of the year, Silvergate has received at least $3.6 billion in financing from federal home loan banksA 1930s-era system that first dealt with mortgages.

To pay for it, Silvergate sold more bonds. It’s not ideal, and it’s part of the reason Silvergate is in trouble. “If you’re a bank, you don’t want to point in the wrong direction, because it becomes self-fulfilling.” writes BloombergIn Levin. In fact, this is why many of Silvergate’s core customers are intimidated. Levine thinks some regulators may be interested in crypto banking.

In fact, the judiciary is already interested. There are some questions surrounding the strange transactions at Silvergate.

For example, finance. Its independent arm, Binance.US, transferred more than $400 million to trading firm Merit Peak Ltd. Reuters reported. The company is managed by Binance CEO Changpeng Zhao. “Then the CEO of Binance.US, Catherine Colley, wrote to Binance’s financial administrator in late 2020, asking for an explanation for the transfers, calling them ‘unexpected’ and ‘no one mentioned'” Reuters wrote Those transfers took place on Silvergate’s specialty network SEN.

This is similar to some of the issues Silvergate faces around FTX. Alameda Research, a trading firm owned by Bankman-Fried, opened an account with Silvergate in 2018. Bankman-Fried admitted to using the Alameda accounts for FTX funds.

I don’t know if Silvergate did anything wrong. Maybe it isn’t! But are central banks starting to ask questions? It’s a headache and a distraction. This is the last thing a troubled bank needs.

Many of the companies banking with Silvergate are talking here about how they have minimal exposure, which historically isn’t a great sign. (See: Bankman-Fried’s infamous “FTX is good. Assets are good,” he tweeted.)

But you know what? In this particular case, I tend to believe them. First, the money that left Silvergate already exists. But secondly, Silvergate is a pass-through bank for crypto; It does not hold on reserves and it does not pay interest. The problem here is that some exchange or stablecoin is going to suffer a huge loss of client money, and less so than it is now. Banking is even harder for crypto companies.

Banks are in dire need of the crypto industry. But both Silvergate’s rivals, Metropolitan and Signature, were pulling out of the field before the debacle. Metropolitan said that in January Getting all the way from crypto. In December, Signature said it was leaving Eliminate $8 billion to $10 billion in digital asset-related funds.

Not sure if Silvergate is going to come through this. But I strongly suspect that it has become more difficult to get out of crypto to dollars and out of crypto to dollars. Silvergate dealt in liquidity, and a The liquidity problem becomes a solution problem Real fast. The entire crypto industry has become very weak.