Crypto Companies Are Facing A New Problem: Banks May Refuse To Take Their Money

The crypto bank Silvergate Capital SI -57.72% is in crisis mode after disclosing in a securities filing late on Wednesday that it was concerned about its capacity to "remain as a going concern." The news drove the stock plunging 55% on Thursday to about $6 per share.

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The disclosure aroused concerns about Silvergate's (ticker: SI) future partnerships with banks, the liquidity of the token market, and whether anyone could take over the company if it doesn't survive its most recent crisis of confidence.

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When Silvergate informed the Securities and Exchange Commission that it would be missing the deadline for submitting its 10-K annual report, it shook the market. The business also expressed concern about its capacity to carry on and stated that it was "re-evaluating its companies and strategies in light of the business and regulatory issues it currently faces."

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A spokesman for Silvergate stated that the company "is aggressively trying to file their 10-K as soon as feasible."

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Silvergate, situated in La Jolla, California, was established in the late 1980s, but it wasn't until 2013 that management began courting business from the cryptocurrency sector that the company experienced tremendous growth. Companies dealing with digital assets had trouble obtaining banking services. As the price of Bitcoin BTCUSD -4.40% and other tokens skyrocketed, Silvergate pounced and quickly increased deposits from crypto firms. By the end of 2021, Silvergate claimed to have $14.3 billion in deposits.

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With the purpose of facilitating traditional currency transactions between its clients, the company also developed the "Silvergate Exchange Network" (SEN). The network processed transfers of $219.2 billion in dollars during the fourth quarter of 2021. By the end of that year, 894 institutional investors and 94 cryptocurrency exchanges were among its clients. Also, the company provided loans in US dollars to clients who pledged Bitcoin as security.

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Crypto firms were able to skip ACH transfers, which typically take several business days to complete, thanks to the SEN network. According to Silvergate, the network had "near real-time transactions and quick availability of funds," and it ran continuously throughout the year.

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Several companies announced their exit from SEN on Thursday as worries about Silvergate's health grew. Circle internet Finance, which produces the USDC stablecoin USDCUSD +0.01%, tweeted that it was "unwinding certain services" with Silvergate.

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Silvergate payments will no longer be accepted or initiated by Coinbase Global COIN -1.50% (COIN), according to the company. Although Paxos, a stablecoin business, said it no longer processed SEN deposits to its Silvergate account, it continued to handle outgoing transactions.

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A run on deposits also hit Silvergate; it lost $8.1 billion in the fourth quarter, dropping from $3.8 billion to $3.8 billion, wiping out seven years of profits for the business.

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According to John Wu, president of Ava Labs, whose company assisted in the development of the Avalanche blockchain, the current worry is the potential extinction of SEN, which might have significant effects on liquidity in the token market.

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Wu claimed that SEN made it much simpler and quicker to transmit money between investors, exchanges, and market makers. Nearly every other cryptocurrency company and institutional investor also have accounts at Silvergate, according to Wu.

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Wu argues, "We're losing the few tracks we have" for exchanging conventional currency. "If Silvergate fails, it will drive capital and market makers even further offshore."

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Wu claimed that as market makers like Genesis Global withdrew from the market, "slippage" on cryptocurrency trades—the difference between the price at which a trade is anticipated to happen and where it actually executes—had already gotten worse during the previous few months. Liquidity would worsen if Silvergate's network vanished, he claimed.

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Other financial organizations that have courted cryptocurrency users, such Signature Bank SBNY -2.71% (SBNY), which operates a network resembling SEN, have declared that they are diversifying away from the sector. There is therefore little chance that another bank will be able to step into Silvergate's shoes anytime soon.

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Authorities may see the Silvergate situation as just more reason to prevent cryptocurrencies from entering the financial sector. Federal regulators recently released recommendations, cautioning banks about the dangers of engaging in cryptocurrency business but stating that this is not a forbidden activity. In a joint statement released in January, leading regulators, including the Federal Reserve, stated that they were "carefully considering any requests from financial firms to engage in operations that involve crypto-assets."

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According to Todd Phillips, who owns Phillips Policy Consulting and was a senior attorney for the Federal Deposit Insurance Corp., the probable failure of Silvergate would increase the scrutiny.

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According to Phillips, regulators would investigate how unsafe these kinds of crypto activities truly are if Silvergate Bank failed. "It's basic economics if accommodating one industry is more expensive for banks than accommodating another. Banks will have to decide whether or not they wish to bank this kind of industry.