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Wasn’t the contagion over? Not if you ask Silvergate Wasn’t the contagion over? Not if you ask Silvergate Wasn’t the contagion over? Not if you ask Silvergate

Wasn’t the contagion over? Not if you ask Silvergate

Mads Eberhardt

Cryptocurrency Analyst

Summary:  In 2022, there was an avalanche of contagion rocking the crypto industry to its core, following the collapse of crypto hedge fund Three Arrows Capital, retail magnet Celsius, and exchange FTX, among other firms. Now, crypto-focused bank Silvergate is in difficulties upon losing $1bn in Q4 2022 and major clients leaving the bank in large numbers. The consequences for the industry are likely to be severe, as crypto firms scramble to find banks and liquidity dries up.

Until last week, Silvergate was one of a few cornerstones in the crypto industry. Since onboarding its first crypto-related client in 2014, the bank quickly became a favorite among crypto firms at a time when they had difficulties opening a bank account. In 2017, Silvergate doubled down on the crypto industry by launching the Silvergate Exchange Network (SEN), allowing institutional investors and market makers to instantly transfer US dollars to and from exchanges and OTC desks. The network provided Silvergate with a firm network effect, earning them a great clientele of nearly every crypto exchange and institutional investor. In November 2019, Silvergate went public with an offering price of $12, followed up by a two-year sprint to an all-time high of $222.13 in November 2021.

The collapse of FTX initiated the issues at Silvergate

Prior to November 2022, Silvergate promoted its banking services with a quote by FTX co-founder and CEO Sam Bankman-Fried on its homepage. It appears that FTX used Silvergate as its main bank for dollar withdrawals and deposits from clients, likely making FTX one of Silvergate’s largest clients if not the largest. Yet, its partnership with FTX turned ugly within the span of a few days, following the bankruptcy filing of FTX in November last year. The prominent bankruptcy of FTX did not only cause market participants to withdraw funds from exchanges and other crypto intermediaries’, fearing the insolvency of other companies, but the market also questioned whether Silvergate’s partnership with FTX could cause regulatory scrutiny, provoking Silvergate to be hit by two sides.

This double hit on Silvergate prompted clients to withdraw the majority of their deposits from the bank, effectively causing a run on the bank. In early January, Silvergate announced that it incurred a loss of $718mn by selling debt to meet clients’ withdrawals in that fourth quarter of last year. In addition, the bank cut its staff by 40% and wrote off its $182mn acquisition of Meta’s Diem project it carried out early last year.

To make matters worse, Silvergate delayed its annual 10-K report last week, stating that it needs two more weeks to complete the report. It further stated that it expects to incur further losses due to additional debt sold in January and February, saying that: “…the Company is evaluating the impact that these subsequent events have on its ability to continue as a going concern for the twelve months…”. The severe negative outlook caused multiple crypto firms to cease their relationship with Silvergate, including Coinbase, Bitstamp, Paxos, and Circle, including transfers over the Silvergate Exchange Network (SEN). On Friday, Silvergate announced that it will discontinue the SEN based on a “risk-based decision”, altogether sacrificing its competitive advantage coming from the network effect of the SEN. It appears that Silvergate is in talks with Federal Deposit Insurance Corp. officials to potentially salvage the bank. Only time will tell if these talks pay off, yet there are at this time several consequences for the crypto market.

Lower liquidity, fewer crypto-friendly banks, and regulatory scrutiny

There is only a single alternative to the SEN, namely Signature Bank’s Signet. However, it is not nearly as widely used compared to the SEN. Besides, Signature Bank has been on a spree to drastically reduce deposits from crypto to cut down risks, stressed by comments from Signature Bank CEO Joe DePaolo late last year: “We are not just a crypto bank and we want that to come across loud and clear”. This indicate that Signet is in fact not a viable alternative for the majority previously using the SEN. As long as there is no viable alternative, many market makers, OTC desks, and institutional investors are left in the dust, as they can no longer instantly deposit and withdraw US dollars and euros to and from nearly every exchange. This may limit liquidity and efficiency of the market at the expense of traders and other active market participants.

Silvergate may serve as a worst-case scenario in appealing to crypto firms for traditional banks. This may cause banks to be more cautious and less willing to offer services if it relates to crypto at all, effectively harming the industry’s ability to receive a bank account and limiting innovation in the space. Likewise, the fact that Silvergate is a US-regulated bank may prompt regulators to place the industry under severe scrutiny, as they can arguably not afford to cut the industry some slack, as the contagion has now spread to a highly regulated entity in comparison to mostly non-regulated entities failing last year. This implies that the risk of regulatory counter-pressure has increased.


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