Silvergate: One of the Key Banks in Crypto, in Dire Straits
Silvergate, a bank that has been one of the most important financial institutions in the crypto space, is currently facing major challenges, which could put its very existence in danger. The bank has been serving the crypto industry since 2014, initially providing services to the emerging Bitcoin industry, which was struggling to maintain bank accounts. Silvergate’s Exchange Network enabled institutions such as Coinbase, Gemini, and Kraken to transact in dollars around the clock. However, with the recent collapse of FTX, one of Silvergate’s clients, there was an $8.1 billion run on the bank, with 60% of its deposits exiting the bank in just one quarter. This collapse of FTX spooked other Silvergate customers.
The bank is now facing severe liquidity issues, with very few banks willing to touch crypto due to its risky nature. Access to banking that moves at the pace crypto does is rare, and only one other US bank can do it. This has resulted in a broader gap between the price at which a trade is expected to go through at and the actual price at which it executes, making transactions more difficult. Furthermore, Coinbase, Galaxy Digital, Crypto.com, Circle, and Paxos have announced that they will stop using Silvergate, as did other less notable clients, which could push funds and market makers further offshore. If Silvergate goes out of business, the whole crypto industry could be affected.
Silvergate has been an important on-and-off ramp from the US dollar (and the euro) into the crypto world. Stablecoins issued by Circle, Paxos, and Gemini, among others, relied on the Silvergate Exchange Network to make and burn their tokens. Silvergate created tokens when someone deposited a dollar in their bank accounts, and burned tokens when someone took a dollar out. In March 2023, Silvergate announced that it was suspending SEN, effective immediately, which could cause significant problems for the stablecoin industry.
The liquidity issues faced by Silvergate are an issue for the entire crypto industry, which relies on banks to enable them to convert crypto to fiat and back. The potential closure of Silvergate could be a significant setback for the crypto industry, as the bank is critical infrastructure for the entire crypto market. The loss of this infrastructure could push the crypto industry further offshore and make liquidity an even more significant issue, resulting in higher transaction costs, fewer market participants, and greater volatility.
Why is Silvergate Important in Crypto?
Silvergate is one of the most important financial institutions in the crypto industry, serving as an on-and-off ramp from the US dollar (and the euro) into crypto. It provides critical infrastructure, enabling institutions such as Coinbase, Gemini, and Kraken to transact in dollars around the clock. The Silvergate Exchange Network was used by stablecoin issuers, such as Circle, Paxos, and Gemini, to make and burn their tokens, which are backed by cash or cash-like assets. The bank’s collapse could result in a significant setback for the crypto industry, as it would make liquidity an even more significant issue, resulting in higher transaction costs, fewer market participants, and greater volatility.
What are the Issues Faced by Silvergate?
Silvergate is currently facing severe liquidity issues, with very few banks willing to touch crypto due to its risky nature. Access to banking that moves at the pace crypto does is rare, and only one other US bank can do it. Furthermore, with the recent collapse of FTX, one of Silvergate’s clients, there was an $8.1 billion run on the bank, with 60% of its deposits exiting the bank in just one quarter. The loss of FTX’s deposits was a significant blow to Silvergate’s liquidity, which has put the bank in a precarious situation.
To address its liquidity issues, Silvergate has several options. One of the most straightforward options is to attract new deposits by offering higher interest rates or other incentives. This approach can be effective in the short term, but it may not be sustainable if the bank’s financial situation does not improve.
Another option is to raise capital by issuing new shares or bonds. However, this approach may be challenging for Silvergate, given its current financial situation and the reluctance of investors to invest in the cryptocurrency industry.
Silvergate could also explore partnerships or acquisitions with other financial institutions to increase its liquidity and expand its customer base. However, finding a suitable partner or acquisition target can be challenging, particularly given the risks associated with the cryptocurrency industry.
Finally, Silvergate may need to reconsider its risk management practices and reassess its exposure to cryptocurrencies. This could involve reducing its exposure to riskier cryptocurrencies or implementing stricter risk management policies to protect against potential losses.
Overall, Silvergate faces significant challenges in addressing its liquidity issues. However, the bank has a track record of innovation and agility in the cryptocurrency industry, and it may be able to find creative solutions to its current challenges.
The real estate connection that Silvergate had before its foray into the world of crypto proved useful for the bank in 2022 when it received at least $3.6 billion in funds from Federal Home Loan Banks, a system that was initially created to deal in mortgages. However, to pay that off, Silvergate had to sell off more bonds, which is part of the reason why the bank is in trouble. The bank’s main focus became crypto, which was a rocket ship for its business. As a result, real estate became less of a priority for Silvergate.
The Justice Department is interested in Silvergate due to some questions around bizarre transactions that took place at the bank. For instance, Binance, a crypto exchange, transferred more than $400 million to a trading firm managed by Binance CEO Changpeng Zhao on Silvergate’s special network, SEN. Silvergate also faces problems around FTX, a trading firm owned by Bankman-Fried, which commingled customer funds with those for the trading firm.
It is unclear whether Silvergate did anything wrong. However, having regulators start poking around and asking questions is a headache and distraction that is the last thing a troubled bank needs. Many of Silvergate’s major customers are spooked, and this may get some regulators interested in crypto banking.
The crypto industry desperately needs banks, but both of Silvergate’s competitors, Metropolitan and Signature, were pulling away from the sector even before this debacle. Metropolitan said in January that it was getting out of crypto, while Signature said in December that it would get rid of $8 billion to $10 billion in digital asset-related funds. With Silvergate facing severe liquidity issues, it has become even harder for crypto companies to get banking. The entire crypto industry has become a lot more fragile, and it remains to be seen whether Silvergate can come through this.