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Silvergate’s ‘Worst-Case Scenario’ Fuels Wider Concern on Crypto

Silvergate’s ‘Worst-Case Scenario’ Fuels Wider Concern on Crypto

(Bloomberg) -- Silvergate Capital Corp. made one of the US banking world’s biggest bets on crypto. Now it’s reeling from a run on deposits and a massive loss, intensifying fears the collapse of crypto exchange FTX may seep elsewhere into the financial system.

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“The worst-case scenario seems to have come to pass” for Silvergate, Jared Shaw, an analyst at Wells Fargo & Co., said in a note after the company’s announcement. Silvergate shares cratered a record 49%.

The stunning collapse of Sam Bankman-Fried’s FTX crypto empire, followed by his arrest in the Bahamas and extradition to the US last month, is rippling through parts of the banking industry. While federal regulators have said the broader financial system is largely unaffected, the meltdown, marked by billions of dollars lost, has spurred calls for watchdogs to prevent further calamities.

Also on Thursday, crypto brokerage Genesis let more than 60 employees go in another round of cuts, amounting to roughly 30% of its workforce.

The setbacks have unnerved investors and caught the attention of US regulators, amid concern that some banks pushed too far and too fast into digital assets. Silvergate said Thursday that it’s slashing staff and pulling the plug on one of its crypto ventures. That came the same week that three major US regulators issued a warning to lenders that uncontrolled risks can’t be allowed to contaminate the banking system, and that the agencies will take a go-slow stance on approving any new ventures.

Based on the regulators’ joint statement and the problems that have arisen from FTX’s relationships, it’s likely all banks with ties to crypto are going to face an increased level of oversight from examination teams, Sultan Meghji, former chief innovation officer for the Federal Deposit Insurance Corp., said in an interview.

“Whether or not it’s been announced publicly, I think there’s a serious push to get crypto completely separated from the US banking system,” Meghji said.

Risk Control

The Federal Reserve, FDIC and Office of the Comptroller of the Currency weighed in earlier this week, saying it’s important to prevent risks that can’t be controlled from migrating into the banking system. Representatives for the Fed and OCC declined to comment on Silvergate, and a representative of the FDIC said the agency doesn’t comment on open and operating institutions.

Todd Baker, a senior fellow at Columbia Business School and a former chief strategy officer at three large banks, said Silvergate appears to have staved off insolvency, at least in the short run. But the problems show the perils crypto-focused banks have in managing volatility and risk, he said.

“Ultimately, the bank is going to have to abandon this crypto-first business model if it wants to continue doing business,” he said.

Silvergate’s struggles serve as a cautionary tale for lenders looking to make inroads into the digital-asset industry as a new area for growth. While most of the nation’s biggest banks have avoided diving into the business, Bank of New York Mellon Corp. said in October it would launch a digital-asset platform in the US to allow some clients to hold and transfer Bitcoin and Ether. Those plans from the custody bank differ from the services Silvergate offers as a deposit-taking lender.

“The volatility in crypto, which is reflected in Silvergate’s performance, will cause the rest of the banks to be more cautious in ways to get clarity from regulators,” Wells Fargo’s Shaw said in an interview.

Shares of Silvergate tumbled after the bank said it fired 40% of its staff and lost $718 million selling securities and related derivatives to cover customer withdrawals, which totaled $8.1 billion of digital-asset deposits during the fourth quarter.

Digital Affirmation

The company said it “still believes in the digital-asset industry,” and is committed to maintaining a “highly liquid balance sheet with a strong capital position.”

“In response to the rapid changes in the digital asset industry during the fourth quarter, we took commensurate steps to ensure that we were maintaining cash liquidity in order to satisfy potential deposit outflows, and we currently maintain a cash position in excess of our digital asset related deposits,” Chief Executive Officer Alan Lane said in a statement.

The CEO said on a conference call with analysts that Silvergate might even become a takeover target by a bigger bank that wants to get into the crypto space.

“I think them being a sale candidate was always a consideration, as we are seeing now its hard to run a business that is so concentrated, and it always made sense to be a part of a larger, more diverse institution,” KBW analyst Mike Perito said in an email. “Near term, I imagine any sale would be challenging, though, until the crypto backdrop is a little cleaner.”

Silvergate once saw the crypto industry as a huge growth opportunity. Over the course of a decade, it transformed itself from a firm catering to small businesses into a publicly traded company known for providing banking services to major crypto clients such as Coinbase Global Inc. and Gemini Trust Co. — as well as FTX and Alameda Research.

The arrangement was going well, with Silvergate shares soaring to an all-time high of $222.13 in late 2021 as digital-asset prices set records. Then a painful crypto winter set in, with the value of virtual coins sinking, followed by FTX and its sister entities spiraling into bankruptcy in November.

The thesis behind Silvergate’s crypto-focused payment platform, known as the Silvergate Exchange Network, is a relatively simple one: Crypto companies that might otherwise have trouble finding a banking partner can put their money on the platform and send it to each other in exchange for digital assets. Silvergate’s network is only for US dollars and euros, and virtual-currency transactions don’t take place on the platform.

The deposits placed on the system don’t pay interest, giving Silvergate an almost-free method of funding its activities, and deposits from digital-currency customers swelled during crypto’s heyday. With the stunning collapse of Bankman-Fried’s empire, however, Silvergate’s big bet on crypto has made it a target of short-sellers and attracted the scrutiny of lawmakers including Senator Elizabeth Warren.

Signature Bank, which said in December that it intended to shed as much as $10 billion deposits from digital-asset clients, is also suffering in the wake of FTX’s collapse. Shares of the company fell 4.4% to $112.80 Thursday.

--With assistance from Allyson Versprille and Lydia Beyoud.

(Updates with Genesis in the fourth paragraph, comment from analyst starting in the ninth.)

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