Uh oh! The crypto collapse has reached the real financial system

Silvergate, one of the most important banks in cryptocurrency, is in big trouble. It may be an existential problem.

Silvergate didn’t start with cryptocurrencies. It started with real estate. However, in January 2014, banks jumped into Bitcoin, unstable year — Bitcoin started the year at $770 and closed above $300 in December. “Some of the companies that were forming at the time to serve this budding bitcoin space were having trouble finding and maintaining bank accounts,” he said. Silvergate CEO Alan Lane said on the June 2022 episode odd lots podcast“That’s where we really started.”

Banks’ focus was institutions, while others were working with consumers. For example, Genesis, the now-bankrupt DCG crypto lending subsidiary, was one of Silvergate’s early clients. The bank has developed the Silvergate Exchange Network, a way for cryptocurrency institutions such as Coinbase, Gemini and Kraken to trade on his dollar 24/7. “We got them all,” Lane said in 2022. Anyone serious about regulation. “

Also, Lane’s client has FTX. Federal prosecutors are now investigating Silvergate’s role In Banking in Sam Bankman Freed’s Collapsed Empire. The more pressing issue is that FTX’s demise has taken other of his Silvergate clients by surprise. Bank run on $8.1 billion: 60% of deposits left in just a quarter. (“worse than the average bank closing in the Great Depression”) of wall street journal Easy to understand. )

In the earnings report, Silvergate’s results were Last quarter was absolute shit, a loss of $1 billion. Then, on March 1st, Silvergate made a surprise regulatory filing. It actually quarterly results worseand It is not clear if the bank will be able to continue operating.

In response to the, coin baseGalaxy Digital, Crypto.com, circleand Paxos They said stop using Silvergate – like they did Other less prominent clientsTether, the controversial stablecoin, had its own set of problems with banking. I got a popup telling me I wasn’t using Silvergate..

A client’s laundry list helps explain why Silvergate’s plight is terrifying. Few banks touch cryptocurrencies as it is very risky. Also, most traditional banks do not allow a cryptocurrency customer to trade with her dollars 24/7. Access to a bank that moves at the pace of cryptocurrencies is rare, and there is only one other US bank that can do it.

“Funds and market makers will be pushed further offshore if Silvergate goes bankrupt.” Ava Labs President John Woo said: BaronsThe question is how easy it is to have real cash dollars, which in financial terms is called liquidity. Less liquidity makes trading more difficult. Wu said there is already a large gap between the price at which the transaction is expected to be completed and the price at which it is actually executed.

Therefore, Silvergate’s troubles are problems for the entire cryptocurrency industry.

Silvergate’s SEN was a significant entry and exit from the universal dollar (and universal euro) to cryptocurrencies. In 2022, Lane said all “regulated, U.S. dollar-backed stablecoin issuers” will be banking with Silvergate.

But for stablecoins issued by Circle, Paxos, Gemini, etc., SEN is key to creating and burning the tokens issued when someone deposits $1 into a Silvergate bank account. said Lane.

Silvergate was a transit point for virtual currency.At least a dollar-backed stablecoin theoretically Cash or cash-like assets are held somewhere. (The reason Tether is controversial is that there are doubts about the existence and value of its reserves.) Silvergate’s job is to create tokens when someone puts dollars into USDC, and someone withdraws dollars. “We are an important part of the infrastructure when people want to exit the ecosystem and go to cash. ,” Lane said in 2022.

You’ll notice I said “was”. because it’s March 3rd Silvergate has announced that it will suspend SEN.immediately effective.

The dollar side of the deal meant that Silvergate’s customers had to store large amounts of cash in banks to pay each other and those who wanted to cash it. To make money here, Silvergate could do a few things. The safest bet is to buy 1-month Treasury bills at the Fed and finish in 1 day.

Now, this is finance, and taking more risk may mean more profit. (Verge Favorite Matt Levine bloomberg Here’s a more detailed analysis of how this worked The problem wasn’t that bonds were so risky, it was that FTX caused a massive dollar outflow and Silvergate suddenly had to raise a ton of money. Unfortunately, that meant selling the bonds at a loss to pay the debt. Ironically, bonds were pretty safe. “If depositors had put their money in Silvergate, the bond would have matured and there would have been enough money left to pay it back,” Levine said.

Silvergate has another way to get in touch with stablecoins besides acting as a trading entry and exit point. In January 2022, it purchased assets from Facebook’s failed stablecoin attempt Libra (later renamed Diem). Diem available by the end of the yearThe goal was a digital payment network.

One of the other services offered by Silvergate is Ability to Lend Dollars Against BitcoinWell, Silver Gate said in January “All of our SEN leveraged loans continued to perform as expected, with no losses or forced liquidations,” it said in its fourth quarter earnings call. Maybe these loans are okay! Silvergate doesn’t appear to have done anything particularly dangerous elsewhere.

However, if you want to borrow a dollar loan using bitcoin, I think it is becoming more and more difficult.

Silvergate lived a pre-encryption life: It was a small bank that specialized in real estate transactions in Southern California. During that time, no deposits exceeded $1 billion. financial timesAnd Silvergate needed a deposit. When Lane turned his company toward cryptocurrencies, the business ballooned. By 2021, Silvergate’s fortune will exceed his $10 billion.of The bank went public in 2019 At $12 a share, it peaked at over $200 a share in 2021. (The stock closed at $5.77 on March 3.)

Since cryptocurrencies have been a rocket ship for banks, real estate has become less and less of a focus. But its real estate ties have proven useful for Silvergate in 2022. In the last quarter of this year, Silvergate has raised at least $3.6 billion in funding from the Federal Home Loan Bank.a system originally from the 1930s that also handled mortgages.

To pay it off, Silvergate sold more bonds. This is not ideal and is one of the reasons Silvergate has problems. “If you’re a bank, you don’t want to be misguided because it becomes self-fulfilling.” write bloombergLevin ofIn fact, this is why many of Silvergate’s major customers are upset. Levine believes this could make some regulators more interested in crypto banking.

In fact, the Department of Justice is already interested. I have a few questions about a strange transaction that took place at Silvergate.

Binance for example. Its supposedly independent arm, Binance.US, has transferred over $400 million to a trading firm called Merit Peak Ltd. Reuters reportThe company is managed by Binance CEO Changpeng Zhao. “Then Binance.US CEO Catherine Corey wrote to Binance finance executives in late 2020 asking for clarification on the transfer, saying it was ‘unexpected’ and ‘no one mentioned it’. said Reuters I have written. These transfers were made on SEN, Silvergate’s special network.

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

I don’t know if Silvergate did something wrong. It probably wasn’t! But will the Federal Reserve start asking questions? It’s a headache and a distraction. It’s the last thing a troubled bank needs.

Many companies using Silvergate have talked about minimizing their exposure to Silvergate, which historically doesn’t bode well. (look: Bankman-Fried’s infamous “FTX is fine. Assets are fine” tweet.)

But what do you know? In this particular case, I tend to believe them. First of all, just money has already left Silvergate. But secondly, SIlvergate was a cryptocurrency pass-through bank. It held no reserves and paid no interest. The issue here is not that some exchanges and stablecoins end up losing a lot of money to their customers, it goes beyond that. It’s even harder for crypto companies to get their hands on banks.

The Crypto Industry Desperately Needs BanksBut Silvergate’s competitors Metropolitan and Signature had pulled out of the space even before the debacle. In January, the Metropolitan get out of the cipherAnd in December, Signature Remove $8 billion to $10 billion in digital asset related funding.

I don’t know if Silvergate can get past this. However, I strongly believe that it has become very difficult to get dollars from cryptocurrencies and move from cryptocurrencies to dollars. Silvergate deals with liquidity, Liquidity issues can become solvency issues Really fast. The entire crypto industry has become more vulnerable.