Proactive Investors - Silvergate Bank, once a traditional financial institution, today faced the music and voluntarily decided to liquidate its holdings, bringing an end to Silvergate Capital’s 10-year experiment in the volatile cryptocurrency markets.
Here’s what happened.
Silvergate Bank: The sales pitch
To clarify: Silvergate was not a crypto bank in the Celsius Network sense. It didn’t facilitate lending and borrowing of cryptocurrencies. It was also regulated by the Federal Deposit Insurance Corporation (FDIC), just like any typical bank.
Rather, Silvergate was a bank to the crypto industry.
Here was its rough sales pitch (I’m paraphrasing):
- Silvergate was a bank regulated by FDIC, the Federal Reserve and the California Department of Financial Protection and Innovation, just like any other standard bank
- Silvergate Bank was the first regulated bank to develop a real-time payments system for the crypto market, known as the Silvergate Exchange Network (SEN).
- Silvergate didn’t hold any cryptocurrencies directly but the network acted as a payment system for crypto exchanges and institutions to exchange dollars or euros in real time. This was extremely useful for the 24/7 nature of the crypto markets
- Silvergate didn’t charge clients fees to use the SEN network, but it benefitted from the large sums of non-interest-bearing deposits it received, which it invested in government bonds
According to the bank’s last financial update, for the fourth quarter of 2022, Silvergate had 104 digital asset exchanges on its client list. Coinbase (NASDAQ:COIN) was one of them until jumping the sinking ship.
Silvergate also had 1,025 institutional digital asset investors on its client base, but it is obvious where the money was being made: Of the US$3.8bn in deposits held by crypto clients, over 75% came from digital asset exchanges.
Since we’re on the subject of financial statements, there were a few more red flags in the report, namely a 500% increase in short-term debt to US$4.3bn and a 250% increase in interest-bearing liabilities.
Total net losses for the quarter approached one billion dollars.
Shocking figures, but how did it get so bad in the first place?
Markets tank, clients jump
The obvious answer is, the crypto markets went downhill, which of course they did.
Over two-trillion dollars was wiped from the crypto markets in 2022, starting in May with the collapse of Terraform Labs and culminating with the collapse of FTX.
FTX, by the way, was a huge supporter of Silvergate.
Silvergate was intrinsically linked to the formation of Sam Bankman-Fried’s FTX, formerly the second-largest cryptocurrency exchange before imploding in a whirlpool of criminal fraud and severe professional misconduct allegations.
“Life as a crypto firm can be divided up into before Silvergate and after Silvergate,” Bankman-Fried once said of Silvergate. “It’s hard to overstate how much it revolutionised banking for blockchain companies.”
That would have been a stunning endorsement back in the day, but it became a curse when Bankman-Fried turned out to be one of history’s greatest frauds.
Anyway, the markets enjoyed a strong rebound in the opening months of 2023, but there were cracks festering within Silvergate.
Those cracks became significantly wider in early March, when Silvergate delayed its annual earnings call, saying that it probably wouldn’t be able to meet extended deadlines due to ongoing investigations and internal audits.
Silvergate initially requested additional time to allow for an audit, including “the evaluation of the effectiveness of the company’s internal control over financial reporting”.
More foreboding still was the group’s admission that significant financial losses felt in 2022 were impacting Silvergate’s ability to operate “as a going concern” in the year ahead.
High-profile clients, including Coinbase, Paxos, MicroStrategy, Circle, Crypto.com, Bitstamp, Galaxy and Gemini began publicly distancing themselves from the bank.
All eggs in one digital basket
But back up a bit, Silvergate didn’t hold crypto assets, it held cash deposits. Furthermore, its investments were mainly in government bonds, not risky loans. What gives?
As the Wall Street Journal today stated, “credit risk – or the risk of not being paid back – isn’t the only kind of risk banks face”.
What Silvergate faced was interest rate risk in the firm of surging central bank rate hikes which saw bond prices fall precipitously.
Since 2013, under Alan Lane, Silvergate pivoted its business model to catering a niche thing called cryptocurrency.
“We began pursuing digital asset customers in 2013 and have been deliberate in our approach to serving this community since then,” the website still reads as a sort of sober reminder.
For a long time, it was laughing all the way to… itself? When bitcoin and cryptocurrency became mainstream and the market doubled, quadrupled, sextupled in value, so did Silvergate’s balance sheet.
A myriad of crises later and the markets absolutely tanked, severely impacting pretty much all of Silvergate Bank’s major clients and carving up its balance sheet.
Facing the inevitable, on March 8 Silvergate announced the following: “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.”
One gets the sense of a running theme in Silvergate’s business decisions.
Focusing on one particular client type and investing in one particular asset class? Probably not a great idea.
That’s basic first-year business school stuff.