With Silvergate Gone, Who Remains?

Silvergate, the cryptocurrency-focused bank, announced on Wednesday it is closing its doors, adding to the carnage resulting from the FTX’s collapse.  Silvergate’s decision to wind down stems from the bank’s connection with FTX, with the company saying in a statement, “In light of recent industry and regulatory developments, Silvergate believes that an orderly wind-down of Bank operations and a voluntary liquidation of the Bank is the best path forward.”

While FTX filed for bankruptcy in November 2022, its effects are still felt across the industry months later. The exchange has also been facing allegations of fraud that put a heavy spotlight on Silvergate, sparking a regulatory crackdown on the industry’s relationship with banks.

Thankfully, Silvergate has indicated that all deposits will be fully repaid, but did not disclose how it plans to settle claims against its businesses, according to a liquidation plan shared on Wednesday. Centerview Partners will serve as Silvergate’s financial adviser, while Cravath, Swaine & Moore will serve as legal counsel.

The news of voluntary liquidation comes after last week when Silvergate Bank closed down its critical cryptocurrency payments network known as Silvergate Exchange Network or ‘SEN’. Considered one of its key offerings, SEN allowed customers to conduct transactions 24/7 and was used by institutional investors to move funds around cryptocurrency exchanges.

Interestingly, investment firms BlackRock and Citadel Securities recently took large stakes in Silvergate, buying 7% and 5.5%, respectively.

Meanwhile, cryptocurrency companies such as Coinbase, Kraken, Galaxy Digital, Circle, Crypto.com, Gemini, and Bitstamp rushed in to break their links to Silvergate after the bank warned it was not sure whether or not it would stay in business.

Bitcoin mining firm Marathon Digital has also halted its loan facility with Silvergate Bank, stating in a tweet that the company has “repaid its term loan and terminated its credit facilities” with the bank, which lowered Marathon’s debts by $50M and increased the company’s unrestricted Bitcoin holdings by 3,132 BTC.

Crypto Market Takes a Hit

Silvergate has been struggling for months. In addition to furloughing 40% of its workforce in January, Silvergate posted $1 billion in losses for the fourth quarter of 2022. And it is bleeding even more equity this year, forcing it to postpone its annual report.

Last week, the US lender delayed filing an annual 10-K for 2022 with the Securities and Exchange Commission (SEC), chalking it up to sorting through the “viability” of its business, pending a regulatory crackdown that includes an already-underway Justice Department investigation, Congressional inquiries, and investigations from its banking regulators, including the Federal Reserve and California’s Department of Financial Protection and Innovation.

The bank has also been under fire from short sellers, abandoned by depositors, and shunned by business partners.

All of this raised questions about whether the crypto bank could stay in business and sent the market crashing with Silvergate’s stock plunging. As of writing, SI is trading at $2.46 in the pre-market, down almost 99% from its Nov. 2021 high of $204.5.

Meanwhile, Bitcoin is trading at $21,640, Ether at $1,532, and the total cryptocurrency market cap is barely keeping above the $1 trillion mark.

The same day, Fed Chairman Jerome Powell also reiterated that the central bank is likely to raise rates higher than it had previously anticipated and could move at a faster pace if economic data keeps coming in hot. However, he said no decision about what’s to be done at the March policy meeting had been made yet.

Amid all this, the embattled firm Grayscale has gained optimism that it could prevail in its legal battle challenging the US SEC’s decision to deny the conversion of its bitcoin trust (GBTC) to an exchange-traded fund (ETF).

Traditional Banking Risks

Before Silvergate announced it was shutting down, the cryptocurrency-friendly bank was in talks with US regulators about finding a way to keep from going bankrupt. Officials from the FDIC arrived at the company’s headquarters in La Jolla, California, intending to avoid Silvergate being the US banking system’s first casualty in the crypto implosion.

Among the options they discussed was finding crypto investors to help bolster liquidity as banks suffered mounting losses. But the rounds of despairing calls to prospective investors failed, and there was not one company prepared to be associated with a bank involved in the industry’s upheaval.

“Silvergate’s troubles are as much if not more about traditional banking risks—lack of diversification, maturity mismatches—as it is about its exposure to crypto,” said Sheila Bair, who headed the FDIC during the Global Financial Crisis.

Launched in 1988, Silvergate originally made loans to industrial customers, dealing in traditional services like commercial and residential real estate loans. Decades later, in 2013, it started transforming itself from a typical community bank into one catering to the digital asset industry and began accepting deposits from institutional crypto players.

In 2018, Silvergate introduced a cryptocurrency payments platform that allowed customers to exchange fiat currencies as quickly as digital assets traded on systems other than the bank, like FTX.

When it comes to Silvergate’s downfall, the bank’s balance sheet also had a key role. The bank did not pay interest on deposits received from crypto customers, meaning it had a pool of free funds plowed into mortgage-backed securities and bonds sold by state and local governments.

While this setup is not unusual for any bank, it proved troublesome when the Fed raised interest rates, depressing the value of some of Silvergate’s securities.

As the cryptocurrency sector tumbled and customers scrambled to withdraw their cash-, it pushed the lender’s interest-free deposits down from $12 billion in late September to only $3.9 billion by the end of last year, which forced Silvergate to sell securities to cover these withdrawals. But because the bonds were worth less than what the company paid, they had to sell them at a loss, blowing a $1 billion hole in its earnings at the end of last year.

“They failed to see that rising interest rates would radically affect the volatility of those deposits,” said Todd Baker of Columbia University’s Richman Center for Business, Law, and Public Policy, in an interview with Bloomberg. “They also failed to understand that the value of their securities portfolio would plummet when rates rose.”

Meanwhile, US prosecutors from the DOJ’s fraud unit have been looking at the bank’s relationship with FTX and its brokerage firm, Alameda Research. The criminal probe is looking at accounts Silvergate held for SBF’s business. So far, the bank has not been charged with wrongdoing, and the probe may conclude without charges being filed.

SEN Death Creates a Hole

Silvergate has been serving as one of two major banks for cryptocurrency companies, alongside Signature Bank, which offers a program called Signet that was launched in 2019 and uses blockchain technology to enable real-time settlements. Compared to Silvergate’s $11 billion, Signature holds more than $114 billion in assets.

The crypto bank’s SEN service played a critical role in helping to facilitate the transfer of funds off the blockchain between large investors and crypto exchanges. At its peak, during Q4-2021, SEN had grown to handle more than $219B worth of transfers, earning $9.3M in revenues.

Silvergate had all the supposed protections of a bank with regulatory oversight. It was licensed by the FDIC, Fed, and the California Department of Financial Protection and Innovation and had been operating within crypto while staying out of the cryptocurrency markets themselves. Despite that, Silvergate has met its demise.

Currently, there seem to be no immediate plans for SEN to resume operations. However, there’s a chance that a company looking to establish itself in the industry could acquire SEN, given its successful track record. Meanwhile, experts in the field are evaluating the significance of SEN as a key player in the cryptocurrency market infrastructure and considering alternative blockchain companies or legacy banks that could potentially take its place.

“It’s hard to know just how damaging the loss of SEN would be right now,” said Noelle Acheson, former head of research at Genesis Trading. “I suspect it was probably a low fraction of what it used to be, so the immediate impact is not that significant. It’s more a regrettable removal of a convenient service.”

Banks have always been reluctant to engage with the volatile crypto industry, and the exit of Silvergate will further exacerbate the situation. However, the crypto industry is adapting and taking on the responsibility itself.

The payments processor for the crypto banking company BCB Group is fast-tracking plans to add US Dollar capabilities (it currently deals in Euro and British pounds) to help plug the holes left by SEN. Additionally, stablecoins like Circle’s USDC or Tether’s USDT may get increased adoption. A Kaiko report said that “stablecoins will likely become even more ubiquitous among traders” with the “death” of SEN.

But this is not all. Kraken recently announced they would be starting Kraken Bank to fill in the gaps left by the traditional banks. This move shows the resilience and determination of the crypto industry to provide financial services to users despite the challenges they face.

Crypto Industry Takes the Charge

Despite ongoing regulatory crackdown in the US, cryptocurrency exchange Kraken is looking to start its own bank. Kraken Chief Legal Officer, Marco Santori, confirmed the same in the Scoop Podcast, saying, “Kraken Bank is very much on track to launch very soon.”

The exchange originally secured the Wyoming state government’s approval for a special purpose depository institution (SPDI) in 2020.

At the time, the company said Kraken Bank was the “first digital assets firm in US history” to obtain a bank charter recognized by Federal and state laws. Kraken will be the first regulated US bank to provide “comprehensive deposit-taking, custody and fiduciary services for digital assets,” it added.

Based in Cheyenne, Kraken Bank was initially planned for launch in 2021, followed by phases of launches through 2022. But now, after several setbacks and delays, Kraken Bank could finally become available.

Once it starts operating, the bank’s services will be first rolled out to existing U.S.-based Kraken customers, with a potential international expansion down the line. However, the bank does not intend to offer in-person services, rather keeping all operations online and via mobile devices.

“We’re returning to an era where banks are going to be very cautious as to what accounts they open,” said Santori. “Wall Street is going to be fine. Kraken and Coinbase are going to be okay. But for the guy or gal who has a new idea about how to provide infrastructure to the crypto economy, it’s going to be a really tough road over the next few years for them. No question.”

This past year, many crypto firms like FTX, BlockFi, Celsius, Voyager, Genesis, Three Arrows Capital (3AC), and Core Scientific went bust. However, as we saw, many, like Coinbase, Binance, Kraken, Circle, and Tether, are still active and holding strong to support the growing crypto adoption and space.