Summary Silvergate Bank's collapse was triggered by the collapse of FTX, which led to a devastating bank run on the bank. While regulators bear responsibility for not defining a proper framework for the cryptocurrency industry, the management also made mistakes. The failure of Silvergate Bank may have a significant impact on the future of the cryptocurrency industry in the US by removing the main on-ramps for the ecosystem. Silvergate Bank ( SI ) is done. It was a victim of the nature of Bitcoin (BTC-USD), it subsided to a bank run that I would argue wasn't completely their fault, but which they could have cushioned properly if they had less duration exposure on the asset side. But that should point to something that Caitlin Long (Custodia Bank) has been arguing for ages, that the nature of Bitcoin makes it inadvisable for banks accepting crypto deposits to lend money. It's not about solvency, it's about the fact that if you are illiquid, you are effectively insolvent . The Rise and Fall of the SEN Network Silvergate was originally a thrift and loan in San Diego County in the 80s but pivoted to pursue opportunities in residential lending after the subprime crisis. In 2014, they entered the crypto market by offering bank accounts to companies providing services in the Bitcoin space, which led to the creation of the SEN network. The network allows for seamless payment transfers between Silvergate customers and operates 24/7. The company grew their customer base during the crypto winter of 2018 and brought in-house software engineers to add more functionalities to the platform. The SEN network was a fee generator for Silvergate and provided a significant benefit to their clients, while also serving as an anchor for their zero-cost deposit base. The problem arose following the collapse of FTX (FTT-USD), Silvergate faced a significant decrease in digital asset deposits, leading to a restructuring of its balance sheet and prudent policies to withstand potential bank runs. The company took measures to ensure liquidity and accommodate deposit inflows and outflows. Silvergate adjusted its expenses, reviewed its product offerings and customer relationships, and implemented cost-saving measures like reducing its workforce by approximately 40%. Silvergate's management thought it had prudent policies to ensure the safety and accessibility of its deposits. The management team stated that it had structured its balance sheet to withstand a 70% drawdown on deposits and kept cash reserves that exceed all remaining deposits. However, at many levels, this wasn't enough, just like Caitlin Long had predicted it could happen to banks dealing in Bitcoin. Regulatory Scrutiny and Political Pressure on Silvergate I must say that amidst all the uproar and scathing comments towards the management team, it is crucial that we delve into the root causes of this downfall. Firstly, it all began with the collapse of FTX, which then triggered a devastating bank run on Silvergate, with clients withdrawing a staggering $8.1 billion from the bank . This, in turn, led to a colossal loss of $1 billion due to the bank having to sell off assets, including bonds, at a lower price than their marked value on the balance sheet, thus incurring significant losses and impairing capital. It's not like the bonds held were low on quality, if they were able to hold them to maturity, they would likely be fine. But, this happening in a rising interest rate scenario, made them sell before maturity and crystallizing losses. Nevertheless, the company tried to fight back with decisive actions to mitigate the losses and for a moment seemed to regain control of the situation. But then news surfaced of the Justice Department taking an interest in Silvergate and questioning FTX and Alameda transactions that took place on the SEN network. While it is unclear if Silvergate did anything wrong, having the Feds start poking around and asking questions is certainly a headache and distraction that a troubled bank didn't need. To make matters worse, political pressure on the bank has increased to deafening levels, which has destroyed what little reputation and confidence the bank had left. The pressure grew so intense that the Federal Home Loan Bank of San Francisco demanded the repayment of the $4.3 billion loan that they had provided when the problems started. This loan recall is already stirring up controversy , with some questioning whether it was simply political pressure and cherry-picking rather than a neutral regulatory decision. The final nail in the coffin was the bank's delayed annual report , caused by the need to reevaluate the losses incurred and its ability to continue as a going concern. This led to its clients losing confidence in the bank and stopping the use of its SEN network, effectively killing it. Without its SEN network, the very reason for the bank's existence was mostly over. In a matter of days, the bank went from delaying the annual filing to liquidation. A Post-Mortem of Silvergate Bank While it is true that regulators, politicians, and the macro scenario contributed to the bank's woes, the management team had a role to play as well. First, they directed the bank's funding toward the cryptocurrency business. In hindsight, they could have diversified the sources of funding or been more conservative in the deployment of funds. While it is easy to second-guess their decisions now, we must remember that a big part of their job is to understand and manage risk. We can now say that they were overtly exposed to interest rate risk. On the asset side, they held bonds that went down with rising interest rates, and on the funding side, they had clients dealing in an asset class that was tremendously sensitive to interest rates. Their business was also highly sensitive to the rate cycle, making them vulnerable to market shifts. The most striking issue is that they were paying 0% on deposits and were even being paid to move funds. They could have just held T-bills and earned profits, which would have been less profitable but more secure. As I have pointed out, while the management team made mistakes, the regulators also bear some responsibility. The regulators have been slow and hesitant in defining a proper framework for the cryptocurrency industry, leaving banks like Silvergate in a difficult position. Most agencies seem more interested in extending their reach over to crypto than in understanding the nature of the asset and the proper way to conduct business. They try to adapt twenty-century rules to a twenty-first-century phenomenon, which is not always effective or appropriate. Therefore, it is not surprising that in some instances, litigation is yielding blows to regulators , as their lack of understanding and regulation has led to confusion and uncertainty in the market. In the end, there is some hope that deposits may be repaid in full , and perhaps even investors may receive some compensation. However, we must remember that a loss is still a loss, and it is unlikely that investors will recoup the full value of their investments. While the bank's failure may not be as catastrophic as some we have seen in the past, there is still a risk of contagion to regional and even big banks. This event may also leave scars on the industry, as common on-ramps such as Silvergate and Signature are now off the table. I believe the future of the cryptocurrency industry in the US is hanging by a thread.
