Silvergate Bank Held Major Stablecoin Reserves, Raising Investor Protection Concerns

Stablecoins are meant to be the crypto market's base, faithfully remaining tethered to the dollar even when tokens like Bitcoin fluctuate drastically in value.

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Nevertheless, certain reserve assets underpinning stablecoins were previously held at Silvergate Capital (SI), a bank that is now trying to stay afloat. Experts are concerned about whether some stablecoins were at risk of not being completely supported and what safeguards investors would have if a bank failed.

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Until recently, various prominent token issuers admitted to keeping at least a portion of their reserves at Silvergate in La Jolla, California. The bank said this week that it would postpone submitting its annual report and expressed worry about its capacity to "remain as a going concern," in a securities filing late Wednesday, sending its shares down more than 55% to $5.77 at Friday's closing.

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Token issuers claim that for every token, at least the same amount is held in reserves in secure assets such as Treasuries and cash deposits. Tether Holdings, Circle, Paxos Trust Co., and Gemini Trust Co. have all minted large coins.

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Most coin issuers had reserve deposits with Silvergate, however, they appear to have withdrawn in the last few days.

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Paxos Reserve reports, which issued stablecoins USDP and BUSD, showed Silvergate as one of the banks it uses as of Feb. 28. According to a person acquainted with the situation, none of the reserves for those coins were kept at Silvergate as of March 3.

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Prior to this week, the website of Gemini, the trading platform created by the Winklevoss twins, said that a part of the reserves supporting its stablecoin, GUSD, may be stored at Silvergate, among other banks. "We presently have zero client funds and 0% GUSD funds stored at Silvergate," Gemini tweeted on Thursday.

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A representative for Tether, the largest stablecoin at $73.2 billion, in a statement, stated the corporation "had no exposure to Silvergate. Our reserves continue to be liquid and unaffected."

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Circle, the corporation supporting USDC, the second-largest stablecoin at $43.3 billion, had deposited at Silvergate as of midday Friday, according to a statement given to Trade Algo at the time. It was no longer the case by Friday evening.

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"Circle's first goal is to safeguard the reserve money that underlies USDC. "Today, Circle has shifted the modest amount of USDC reserve deposits held at Silvergate to our other banking partners as a result of continued uncertainty at Silvergate Bank," the company stated in a blog post late Friday.

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Regulators, who were already wary of banks' crypto activities, will likely pay even more attention to deposits of stablecoin reserves now that Silvergate has demonstrated that those deposits can flee at any time, according to Todd Phillips, a former senior attorney for the Federal Deposit Insurance Corp. (FDIC).

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"It demonstrates that these assets are quite volatile," Phillips added. "It is quite easy for these stablecoin issuers to pick up and move large pools of money out of one bank and place them in another," he says, adding that banks may require greater liquidity to manage a rapid withdrawal of stablecoin reserves now that it is clear these corporations may pick up and escape.

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A spokesman for Silvergate declined to comment.

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It's unclear how stablecoin investors would be affected if a corporation holding reserves went bankrupt. The FDIC normally guarantees deposits up to $250,000, however in many circumstances, that limit applies to the coin issuer rather than the individual token holder.

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Several issuers claim on their websites that certain token holders may be protected by "pass-through" FDIC insurance at the person level, which might imply they receive the full $250,000 in protection. Gemini, for example, claims that the cash part of its reserves "may be suitable" for its clients if the bank holding them fails.

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Nevertheless, for pass-through insurance to be available, token issuers would need appropriate records of who possessed each stablecoin that the company could show the FDIC, and investors can't be sure whether an issuer achieves that criterion ahead of time, according to Phillips.

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"The FDIC isn't going to look at these documents until the bank falls," Phillips adds.

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Some analysts dispute if FDIC insurance would kick in. "Just because you claim these coins are FDIC-insured doesn't mean they are," says Lee Reiners, policy director at the Duke Financial Economics Center. "To be honest, I'm not sure how any stablecoin could qualify for pass-through insurance."

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According to an FDIC representative, the government "can't address any open and operational institutions."

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