A Domino Effect – Part One

As of year-end 2022, crypto-focused bank Silvergate’s deposits were over $6 billion. Importantly, Silvergate led a gateway into blockchain for banking; it was willing to fill a gap between crypto and fiat. However, word that Silvergate collapsed due to a weakening in its capital position and a DOJ investigation of Silvergate (e.g., AML, due diligence, criminal activity) leading to growing problems ultimately led to Silvergate’s demise.

Amidst demand for a crypto friendly bank, Silvergate built“the Silvergate™ Exchange Network” (SEN) to enable the efficient movement of U.S. dollars between its digital currency and institutional investor clients’ Silvergate bank accounts and the bank accounts of other Silvergate clients, 24 hours a day, 7 days a week, and 365 days a year. As a result, Silvergate was an attractive option for big players looking for a safe and trustworthy bank. Moreover, Silvergate had a product, SEN Leverage, where it would lend money collateralized with bitcoin.

As of September 2022, Silvergate’s balance sheet reflected approximately $11.4 billion worth of securities and $1.4 billion of loans (i.e., bitcoin and real estate). However, amidst the FTX scandal and FTX’s insolvency, investors were cautious of leaving their money on exchanges—faith in the crypto market was being lost. As a result, loss of faith in the crypto exchanges led to crypto companies asking Silvergate for their money back and thus leading to a bank run, a bank run driven by a loss of faith in the exchanges as opposed to Silvergate itself. Uncertainty plaguing crypto spread to Silvergate in a domino effect ultimately causing Silvergate to close its doors.

By the end of December, non-interest-bearing deposits at Silvergate fell from $13.2 billion to $3.9 billion. As people who had accounts at exchanges moved to close their accounts and cashed out, Silvergate collapsed due to large deposits and other business from crypto exchanges—including FTX, which was one of Silvergate’s largest customers. Furthermore, Silvergate hosted accounts tied to SBF and so FTX’s demise led to the exposure of Silvergate’s incomplete due diligence. With Silvergate’s money tied up in bonds or lent out, Silvergate had to come up with approximately $9 billion to pay out these withdrawals, so the Bank sold half of its bonds and had borrowed $4.3 billion from a quasi-government agency that grants short-term secured loans to banks with short-term liquidity problems: The Federal Home Loan Bank of San Francisco (FHLB). Silvergate’s loan from FHLB was held out as further exacerbating risk into the traditional banking system since the advances Silvergate received from the FHLB further blurred the lines between crypto and traditional financial channels. Silvergate indicated that it had sold additional investment securities to repay the FHLB loans in full.

Ultimately, the lack of trust ensuing in the crypto market post-FTX and rising interest rates continue to have a domino effect in banking. Along with Silvergate, Silicon Valley Bank (SVB), a small, tech-focused lender, had lost roughly $1.8 billion upon a sale of a portfolio of securities estimated to be valued at around $21 billion to meet a decline in customer deposits. Silvergate Bank’s liquidation plan–amidst a DOJ investigation–is said to include full repayment of all deposits. In the words of Matt Levine (Bloomberg), the crypto boom was a low-interest-rate phenomenon; Silvergate was exposed to interest rate risk due to its exposure to crypto investors. When interest rates increased, the deposits and the assets backing those deposits fell in value. With Silvergate’s doors closed, as well as SVB and Signature’s failures, a banking crisis looms amidst a crypto contagion.