Experts issued a warning following the collapse of FTX in November due to the possibility of systemic damage the collapse of the crypto exchange could have to the larger industry. Silvergate, the California-based bank that has established itself as the financial pillar of the cryptocurrency industry, may suffer the greatest loss following FTX itself.
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Banks rely on customer deposits, which fell as FTX, a major client of Silvergate, filed for bankruptcy and as cryptocurrency businesses prepared for the escalating bear market. Almost 90% of the bank’s deposit base came from crypto firms at the time of FTX’s collapse. The effects were felt right away, with the bank losing $8.1 billion in deposits for digital assets in the fourth quarter of 2022 alone. The entire amount of deposits was close to $6 billion by the end of December.
“Almost Nothing You Can Do”
Crypto companies, perceived as defectors by many traditional institutions, have often struggled to find banking partners – somewhat understandable for self-made disruptors – but they still needed traditional banking services for their payroll and burgeoning clients and accounts to fund their finances hold.
While many banks were nervous, Silvergate jumped at the opportunity and rode the wave of crypto’s historic bull market. The share price rose more than 1,500% between November 2019 and November 2021, with Silvergate serving more than 1,500 digital asset and financial technology companies through the end of 2022.
The stock price began to falter with the onset of the crypto bear market following the May 2022 collapse of TerraUSD, and the bankruptcy of industry giant FTX exacerbated this – crypto companies ran out of money to deposit with Silvergate.
As Silvia explained, deposits are the lifeblood of a bank. “Once it gets worse, and so quickly, there’s almost nothing you can do to stop the bleeding,” he said.
With its share price falling, Silvergate was also unable to rely on the capital markets for funding, leading to its SEC filing on Wednesday, in which the bank said it was “less than well capitalized.”
John Popeo, a former FDIC attorney, analyst at the Federal Reserve Bank of Boston and current partner at Gallatin Group, said banks can fail when they reach critical levels of capital or there is a risk of depositor exodus.
If Silvergate failed to meet certain capital requirements, it would receive a notice of corrective action from the FDIC and its constituent agency or the California Department of Financial Protection and Innovation. Silvergate would then have 90 days to raise capital or sell itself to another bank.
In the event of an immediate financial emergency, the FDIC could take over at any time — generally on a Friday night to minimize disruption to the broader financial system. In this scenario, the FDIC could now be looking for an acquirer. Though Wells Fargo is rumored to be a candidate, Popeo cautioned that without direct knowledge, viewers are ill-equipped to speculate.
As of Saturday, Silvergate is still operational, although on Friday night it announced that it would be shutting down the Silvergate Exchange Network, an inter-firm crypto payments solution. Even as other deposit-related services remained operational, share prices fell about 2% in after-hours trading.
A shrinking universe
Crypto companies have already started fleeing Silvergate, but the downstream impact may be just beginning. Silvia said that Silvergate’s exit from the crypto ecosystem — and other banks’ increasing reluctance to partner with the sector — will make it harder for crypto firms to obtain deposit accounts and other essential services. As a result, banking is becoming more expensive for crypto companies as they explore other options, from credit unions to other types of financial technology companies.
“It’s shrinking the universe of potential partners very quickly,” he said.
Some in the crypto industry have pointed the finger at banking regulators, who have issued a slew of statements about crypto-related liquidity risks following FTX’s collapse warning. Nic Carter, a crypto-focused venture investor, described the seemingly coordinated effort by various federal agencies to deny banking services to crypto firms as “Operation Chokepoint 2.0,” a term that has since caught on.
Silvergate’s failure, Silvia added, has a lot more to do with FTX than it does with regulators. “There’s just a lot of problems that banks see without much reward,” he said wealth.
Even the other US bank that has established itself as crypto-friendly, Signature, has shown more reluctance to collaborate with the industry. In December, it announced that it would reduce its deposits tied to cryptocurrencies.
“We’re not just a crypto bank, and we want that to come across loud and clear,” CEO Joe DePaolo said at an investor conference.