What happens if Silvergate fails?

After the collapse of FTX in November, experts warned of contagion, or the systemic damage that the failure of the crypto exchange could cause in the wider sector. The biggest loser after FTX itself may be Silvergate, the California-based bank that has established itself as the financial backbone of the crypto industry.

Banks rely on customer deposits, which have plummeted as Silvergate’s central client, FTX, went bankrupt and crypto companies considered the worsening bear market. At the time of the collapse of FTX, about 90% of the bank deposit basis from crypto companies. It felt the impact immediately, with the bank suffering outflows of $8.1 billion in digital asset deposits in the fourth quarter of 2022 alone. At the end of December, it total deposit sitting around $6 billion.

Although CEO Alan Lane insists that the bank’s mission has not changed, the writing is on the wall for Silvergate’s crypto-focused approach. Its share price has fallen nearly 95% since mid-August, now sitting around $6, and US senators have begun inquired about Silvergate’s relationship with FTX.

The bottom fell out on Wednesday when Silvergate Office has partnered it was unable 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 have turned to the bank for years as one of the only financial partners to serve the volatile industry, some of the major companies in the sector have announced that they have reduced or severed their relationships, including THE CoinbasePaxos, Circle, and Crypto.com.

Onlookers speculate that the Federal Deposit Insurance Corporation will put Silvergate into receivership as soon as Friday, beginning the process of finding another bank to acquire Silvergate or take its deposits. A crypto banking source said luck that Wells Fargo rumored to be the acquirer.

“Silvergate is really a cautionary tale,” said Joseph Silvia, a former adviser to the Federal Reserve Bank of Chicago and a partner at Dickinson Wright. “But there’s still an opportunity there, and I still don’t think cryptocurrency in general is going anywhere.”

‘There’s almost nothing you can do’

Seen by many traditional institutions as renegades, crypto companies often struggle to find banking partners—quite understandable for their own disruptive companies—but they still traditional banking services are required for their payrolls and on-ramping customers, and accounts to hold their savings.

While many banks floundered, Silvergate jumped at the chance, riding the wave of the historic crypto bull market. Its share price pink 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 started to rise at the beginning of the crypto bear market after the breakdown of TerraUSD in May 2022, and the bankruptcy of industrial giant FTX made that worse—crypto companies no longer have money to deposit with Silvergate.

As Silvia explained, deposits are the lifeblood of a bank. “Once that starts to deteriorate, and deteriorates quickly, there’s almost nothing you can do to stop the bleeding,” he said.

With its price flooding, Silvergate was no longer able to rely on the capital markets for funding, resulting in its SEC Filing on Wednesday where the bank said it was “undercapitalized.”

John Popeo, former FDIC attorney, analyst at the Federal Reserve Bank of Boston, and current partner at the Gallatin Group, said banks could fail from reaching a critical level of capital or an exodus of those depositor.

If Silvergate fails to meet certain capital requirements, it will receive a corrective action notice from the FDIC and its leasing authority, or the California Department of Finance and Innovation. Silvergate then has 90 days to raise capital or sell itself to another bank.

In the case of more immediate financial distress, the FDIC can take over at any time—usually Friday night, to minimize disruption to the broader financial system. In this scenario, the FDIC may look for an acquirer now. Although Wells Fargo is rumored to be a candidate, Popeo cautioned that viewers without direct knowledge are ill-equipped to speculate.

As of Saturday, Silvergate was still operating, though it was Office has partnered on Friday night it will stop the Silvergate Exchange Network, a crypto payment solution between different companies. Although some deposit-related services remained operational, share prices fell by around 2% in after-hours trading.

A shrinking universe

Crypto companies have started flee from Silvergate, but the effects below may begin. Silvia said Silvergate’s exit from the crypto ecosystem—and the growing reluctance of other banks 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 narrows down the universe of potential partners very quickly,” he said.

Some in the crypto industry are pointing fingers at banking regulators, who have released several statements after the collapse of FTX warn of liquidity risks related to crypto. Nic Carter, a crypto-focused venture investor, CEBU the seemingly coordinated effort by various federal regulators to deny banking services to crypto firms as an “Operation Chokepoint 2.0,” a term that has since been coined.

The Silvergate failure, Silvia added, had more to do with FTX than regulators. “There are a lot of problems that banks see, without much reward,” he said luck.

Even the other US bank that has established itself as crypto-friendly, Signature, has shown a greater reluctance to work with the industry. In December, this Office has partnered it will reduce its deposits tied to cryptocurrencies.

“We’re 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 retreat of the traditional financial sector, Silvia expressed optimism that crypto will survive – with a small number of companies. And those who survive will still need banking services.

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