What’s going on with Silvergate, the bank that props up the U.S. crypto market?

What’s going on with Silvergate, the bank that backs the US crypto market?

Haru Invest

Earlier this week, cryptocurrency bank Silvergate announced that its exposure to FTX was limited to its deposits. The US bank, which serves the majority of the crypto industry in the country, said it has no loans or investments in FTX.

The bank’s statements succeeded in calming the market, with its stock showing a slight recovery after losing nearly 50% of its value last month.

However, Silvergate is not out of the woods yet. The bank acts as a foundation of the crypto market in the United States and is deeply connected to the global industry. While FTX’s bankruptcy proceedings might have an insignificant effect on its balance sheet at present, the general market downturn is causing its foundations to crack.

What is Silvergate and why is it important for the crypto industry?

The bank began targeting crypto firms as clients as early as 2013 and has become one of the few tradFi institutions to offer services to the industry.

Being first to market, Silvergate has successfully positioned itself as the primary pipeline facilitating the flow of fiat funds and cryptocurrency conversion between exchanges. The company counts some of the biggest crypto companies in the US among its clients – Coinbase, Kraken, Gemini, Genesis, Circle, Bitstamp, Paxos and FTX all use the bank’s services.

Its importance to the industry lies in the licenses it holds in the United States. Silvergate is regulated by the Federal Deposit Insurance Corporation, the Federal Reserve and the California Department of Financial Protection and Innovation.

This type of regulation has allowed the bank to develop a real-time payment system called the Silvergate Exchange Network (SEN), which allows crypto exchanges and institutions to exchange dollars and euros in real time. The service was revolutionary at the time, as no other bank had real-time payment capabilities that would match the 24/7 payment needs of the crypto industry.

As of September 2022, Silvergate had 1,677 customers using SEN and held approximately $12 billion in customer deposits.

Since the bank charges no fees to use SEN and customer deposits bear no interest, it earns money by using the deposits to invest in bonds or issue loans to earn money on the spread. The bank also provides Bitcoin-backed loans through SEN Leverage, but deposits are its main source of income.

According to Forbes, commitments to SEN Leverage reached $1.5 billion in mid-October, up from $1.4 billion recorded in June.

Silvergate and the FTX fallout

In a statement released last week, Silvergate said it had no loan relationship with FTX. However, even if that were the case, outstanding balances on SEN Leverage represented less than 10% of Silvergate’s total assets last month.

Reports also showed that only around $300 million had been drawn on these credit lines as of the end of September, with no reason to worry about that number increasing significantly. Even if it did, all of Silvergate’s loans are over-collateralized, and it has not yet experienced any loss or forced liquidation of collateral, the company said in its mid-quarter update.

In addition to the $1.2 billion in FTX deposits, Silvergate saw around $900 million in additional deposit outflows over the past week.

Although last week’s outflows were not enough to trigger market-wide panic, many feared the contagion from FTX could spread to other creditors. Silvergate’s ten largest depositors — including Coinbase, Paxos, Crypto.com, Gemini, Kraken, Bitstamp and Circle — accounted for about half of the bank’s deposits at the end of the third quarter.

Trouble has already started brewing at Gemini, which halted withdrawals from its Gemini Earn program earlier this week. The New York-based exchange cited issues with crypto lender Genesis, which acted as the program’s official lending partner. Genesis halted withdrawals from its own clients days earlier, saying its exposure to Three Arrows Capital, the company suffered hundreds of millions in losses from the over-leveraged hedge fund.

Gemini noted that none of its exchange funds have been affected by the Genesis issues. Other major exchanges have tried to bury any rumors of insolvency by posting their reservations and pledging to improve transparency efforts in the future.

However, many industry players believe that the worst is yet to come.

Multicoin Capital, a cryptocurrency venture fund with a large investment in FTX, said it doesn’t expect the market to turn around any time soon. In a letter To investors, the company said it expects the fallout from the FTX contagion to continue over the next few weeks.

“Many trading companies will be wiped out and shut down, putting pressure on liquidity and volume across the crypto ecosystem. We’ve seen several announcements on this front already, but expect to see more.

Marc Cohodes, the legendary short seller of Alder Lane Farm, thinks Silvergate will not be immune to the contagion.

In an interview on Hedgeye, Cohodes said Silvergate faces a much bigger danger than they projected to the public.

“If they lose all their depositors, there will be a run on the bank.”

If US regulators start digging deep into Silvergate and the $1 trillion transactions it facilitated, Cohones thinks the bank could be in trouble. He said the investigation into the bank could reveal little to no KYC and AML processes and call into question his involvement in what he calls “the FTX criminal operation”.

Many have accused Cohones of manipulating facts to drive Silvergate shares down. Silvergate must provide quarterly financial statements to US regulators as a regulated institution, outlining its assets and liabilities. The bank’s third-quarter accounts show no risk of default thanks to its oversized loans and healthy asset balance.

Trouble is brewing for Silvergate.

Nevertheless, the list of companies that stop using the bank continues to grow.

FalconX, one of the leading crypto brokerage firms in the United States, has announced that it will stop using Silvergate SEN and wire transfers “effective immediately and until further notice”.

“This action is based on publicly available information about Silvergate and is consistent with other market participants,” the company said in an email to customers. “FalconX continues to operate as usual.”

falconx silvergate
Screenshot showing FalconX’s email to customers on November 18 (Source: Twitter)

The bank was also recently subpoenaed and found to have $425 million in transfers between its crypto bank accounts to South American money launderers. Although Florida courts have yet to rule on whether there is cause for prosecution and forfeiture, the affidavit has raised concerns.

If further investigations into the bank are opened, its remaining depositors could start withdrawing funds. However, financial records show that the bank is fully solvent, so depositors are unlikely to have any difficulty withdrawing.

However, the FTX contagion could affect other Silvergate borrowers. Liquidating their Bitcoin collateral would put additional selling pressure on the already struggling market and trigger more liquidations, with the value of the remaining collateral falling below the value of the loans.

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