After FTX’s collapse in November, experts warned of contagion, or the systemic damage that the crypto exchange’s failure could have on the broader sector. The biggest loser after FTX itself may be Silvergate, the California-based bank that established itself as the crypto industry’s financial backbone.
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Banks rely on customer deposits, which plummeted as Silvergate’s central client, FTX, went bankrupt and crypto companies reckoned with the exacerbated bear market. At the time of FTX’s collapse, about 90% of the bank’s deposit base came from crypto companies. It immediately felt the effect, with the bank suffering from outflows of $8.1 billion in digital asset deposits in the fourth quarter of 2022 alone. By the end of December, its total deposits sat around $6 billion.
Although CEO Alan Lane insisted that the bank’s mission had not changed, the writing was on the wall for Silvergate’s crypto-focused approach. Its share price has dropped nearly 95% from mid-August, currently sitting around $6, and U.S. senators have begun inquiring about Silvergate’s relationship with FTX.
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The bottom fell out on Wednesday when Silvergate announced it would not be able to file its annual report to the Securities and Exchange Commission on time, citing the need to reevaluate its business strategy and “its ability to continue.”
After crypto companies had turned to the bank for years as one of the sole financial partners that would serve the volatile industry, some of the sector’s biggest firms announced they were reducing or severing their relationships, including Coinbase, Paxos, Circle, and Crypto.com.
Onlookers speculated that the Federal Deposit Insurance Corporation would place Silvergate into a receivership as soon as Friday, beginning the process of finding another bank to acquire Silvergate or take over its deposits. A source in crypto banking told Fortune that Wells Fargo was rumored to be the acquirer.
“Silvergate is really a cautionary tale,” said Joseph Silvia, the former counsel to the Federal Reserve Bank of Chicago and a partner at Dickinson Wright. “But there’s still opportunity out there, and I still don’t think cryptocurrency generally is going anywhere.”
‘Almost nothing you can do’
Perceived by many traditional institutions as renegades, crypto companies often struggled to find banking partners—somewhat understandable for self-fashioned disruptive firms—but they still needed traditional banking services for their payrolls and on-ramping customers, and accounts to hold their treasuries.
While many banks were skittish, Silvergate leaped at the opportunity, riding the wave of crypto’s historic bull market. Its share price rose more than 1,500% between November 2019 and November 2021, with Silvergate serving more than 1,500 digital asset and financial technology companies by the end of 2022.
Its share price began to teeter with the start of crypto’s bear market following the collapse of TerraUSD in May 2022, and the bankruptcy of industry giant FTX exacerbated that—crypto companies no longer had money to deposit with Silvergate.
As Silvia explained, deposits are the lifeblood of a bank. “Once that starts to deteriorate, and deteriorate that quickly, there’s almost nothing you can do to stop the bleeding,” he said.
With its share price tanking, Silvergate also could no longer rely on capital markets for funding, resulting in its SEC filing on Wednesday in which the bank said it was “less than well-capitalized.”
John Popeo, a former lawyer at the FDIC, analyst at the Federal Reserve Bank of Boston, and current partner at the Gallatin Group, said banks can fail from reaching a critical capital level or an exodus of depositors.
If Silvergate fails to meet certain capital requirements, it would receive a corrective action notice from the FDIC and its chartering authority, or the California Department of Financial Protection and Innovation. Silvergate would then have 90 days to raise capital or sell itself to another bank.
In the case of more immediate financial distress, the FDIC could take over at any time—generally on a Friday evening, to minimize disruption to the broader financial system. In this scenario, the FDIC could be looking for an acquirer now. Although Wells Fargo is rumored to be a candidate, Popeo warned that onlookers without direct knowledge are ill-equipped to speculate.
As of Saturday, Silvergate is still operating, although it announced on Friday night that it would discontinue the Silvergate Exchange Network, a crypto payments solution between different firms. Even as other deposit-related services remained operational, share prices dropped around 2% in after-hours trading.
A shrinking universe
Crypto companies have already begun to flee from Silvergate, but the downstream effects could just be beginning. Silvia said Silvergate’s exit from the crypto ecosystem—and other banks’ increasing hesitance to work with the sector—will make it harder for crypto firms to get deposit accounts and other critical services. As a result, banking will become more expensive for crypto companies as they explore other options, from credit unions to other types of financial technology companies.
“It shrinks the universe of potential partners very quickly,” he said.
Some in the crypto industry have pointed fingers at banking regulators, who have issued a number of statements in the wake of FTX’s collapse warning of liquidity risks related to crypto. Nic Carter, a crypto-focused venture investor, described the seemingly coordinated effort of different federal regulators to deny banking services to crypto firms as an “Operation Chokepoint 2.0,” a term that’s since caught on.
Silvergate’s failure, Silvia added, has much more to do with FTX than regulators. “There’s just a lot of problems that banks see, without a lot of reward,” he told Fortune.
Even the other U.S. bank that’s established itself as crypto-friendly, Signature, has displayed more reticence toward working with the industry. In December, it announced it would shrink its deposits tied to cryptocurrencies.
“We are not just a crypto bank, and we want that to come across loud and clear,” CEO Joe DePaolo said at an investor conference.
Despite the traditional financial sector’s pullback, Silvia expressed optimism that crypto would survive—just with fewer companies. And those survivors will still need banking services.
This story was originally featured on Fortune.com
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Source: finance.yahoo.com