One of the core banks of the crypto sector, Silvergate Capital Corp., is being hollowed out in a classic client hideaway familiar to banking history students.
The latest and most serious client exodus from the La Jolla, Calif.-based institution was accelerated this week by the bank’s own disclosures, including an admission that its health could be threatened by “investigations by our banking regulators,” according to a March 1 report by the Securities and Exchange Commission filing. With this disclosure, and Silvergate’s open questioning of the “viability of the company’s digital assets-focused business,” major clients including Coinbase, Paxos, Circle Internet Financial, and Galaxy Digital have decided to sever ties.
The recent tough times for crypto firms have definitely been shared by their favorite banks, but banking regulators have also targeted these lenders with warnings against over-tilting crypto, arguing that banks’ stability could suffer from exposure to a volatile market. Silvergate was basically what they were talking about, as evidenced by the sudden flight of all of its largest crypto clients.
The company had become practically synonymous with crypto banking, and even today, its website’s homepage touts the relationships it forged with the industry after recognizing the “potential of digital currency” in its early years. Part of that relationship may have turned toxic for Silvergate as it was reportedly linked to investigations into FTX’s fraudulent activities.
U.S. banking regulators, including the Federal Reserve and Federal Deposit Insurance Corp., have worked to erect a barrier between the banking system they oversee and the crypto industry, which they have identified as a key threat to traditional finance. The agencies’ policy statements carefully laid out a case against digital asset-focused banks and the companies that issue and trade them. And in a new statement just last week, they again warned banks that their deposits could run out quickly as “customers react to market events, media reports and uncertainties surrounding the crypto-asset sector.”
“They clearly advise extreme caution,” said Alexandra Barrage, a banking attorney at Davis Wright Tremaine who was previously a senior official with the FDIC. She said they probably had Silvergate and similar banks in mind when they issued the alerts, which she says have shown an unusual willingness for banking agencies to “provide some guardrails” about what they don’t want to see.
Silvergate, which has delayed filing its annual report, said this week that it was uncertain it could meet “the increased regulatory scrutiny of banking institutions that provide products and services to the digital asset industry.”
When referring to its banking regulators, Silvergate speaks of the Federal Reserve at the federal level and the California Department of Financial Protection and Innovation at the state level.
One of the jobs of the Fed’s regulators is to monitor an institution’s capital levels and make sure they don’t slip below the danger line. Over the past year, a key metric — Silvergate’s leverage ratio, which measures equity relative to total assets — fell nearly 6 percentage points from a healthy 11% to just over 5%. The threshold at which a bank is still considered well capitalized is 5%, and the bank had already fallen to this level a few months ago.
A bank approaching the 4% risk level will generally hear from the FDIC, Barrage said. The FDIC is the US agency responsible for handling bank failures and ensuring that customers are harmed as little as possible.
“I’m sure there’s a lot of things happening behind the scenes,” Barrage said, adding that they’re probably “trying to figure out if there’s a working fix.”
A spokeswoman for the FDIC told CoinDesk that “we’re not talking about open and functioning institutions.” When asked why the Fed hasn’t intervened so far, a Federal Reserve spokesman declined to comment on its oversight of the institution. However, if regulators had privately stepped in and made demands on the company’s management, their interactions would not necessarily have been public, so it’s unclear just how involved regulators might have been in Silvergate’s struggles. A spokesman for the California regulator also declined to comment.
A Silvergate representative on Thursday declined to delve into the bank’s regulatory pressures and capital woes, sending a statement to CoinDesk saying it was “working diligently” on filing its annual report and had no further comment.
A banking industry veteran who is now in the crypto sector said he wonders why regulators are taking so long to deal with a faltering bank. The executive, who asked not to be named, said the FDIC probably should have knocked on their door months ago.
When banks fail, they usually go under on a Friday night. A crew from the FDIC shows up and takes the keys so their specialists can work through the weekend and have the customer base secure by next Monday. They usually hand over the deposits to a new owner to manage and start looking for buyers for the remaining assets.
Thanks to FDIC insurance, US depositors’ money is safe as long as it does not exceed $250,000. Even if the transfer of ownership doesn’t go smoothly, the federal government guarantees every penny up to the limit — as it has in every banking crisis for the past 89 years — and the FDIC can write a check if there isn’t a new bank to refer customers to can .
The FDIC shut down hundreds of institutions in the wake of the 2008 financial crisis, but hasn’t had to close in the past two years.
However, the agency does not insure any digital assets. All cryptocurrencies held on behalf of customers of a bank are not protected by government protections.
Should Silvergate fail and be caught in an FDIC demolition, it would open up unfortunate new avenues for the industry.
“This would be the first crypto-specific receivership,” Barrage said.