Silvergate Bet Everything on Crypto. Then Everything Vanished.

Silvergate Capital Corp. spent its final days under siege.

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In front of US regulators at the crypto-focused bank's La Jolla, California, headquarters, executives were bombarded by short sellers, abandoned by depositors, and spurned by business partners.

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Federal Deposit Insurance Corp. representatives arrived at the company's premises to prevent the US banking system from being the first victim of the crypto collapse. Finding crypto-investors to support liquidity amid the bank's growing losses was one of the ideas they explored. But, despite frantic inquiries to possible investors, no company was willing to take on the responsibility of working with a bank that was so deeply entangled in the turmoil of the business.

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With no buyer in sight and survival becoming increasingly improbable, Silvergate announced its closure on Wednesday, putting an end to a decade-long crypto dream that made it a key participant as the sector developed. The company's stock, which in November 2021 went for well over $200 a share, fell 36% to $3.14 at 9:31 a.m. New York.

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The decision to wind down and voluntarily liquidate, described by people familiar with the matter who asked not to be identified because they were discussing confidential information, capped months of turmoil at the bank stemming from its ties to Sam Bankman-FTX. Fried's The crypto exchange's November bankruptcy, followed by allegations of fraud, cast a harsh spotlight on Silvergate while also sparking a regulatory crackdown on the industry's ties to banking.

When Silvergate broke under the pressure, incurring $1 billion in losses in the fourth quarter and losing more cash this year, it was forced to postpone its annual report, raising concerns about its ability to continue in business. After tying its wagon so tightly to the new world of crypto, the bank had exposed itself to an old-world banking risk: if the industry's prospects deteriorated, Silvergate had little else to fall back on.

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"Silvergate's problems are as much, if not more, about traditional banking risks — lack of diversification, maturity mismatches — as they are about its crypto exposure," said Sheila Bair, who led the FDIC during the global financial crisis.

Silvergate declined to comment.

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Crypto Pursuit

Silvergate was founded in 1988 to provide traditional services such as commercial and residential real estate finance to industrial clientele. Nevertheless, in 2013, it began to transition from a traditional community bank to one that catered to the digital-asset market. It began taking deposits from institutional crypto players with whom few other traditional banking institutions would do business.

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It launched a crypto-payments platform in 2018, allowing clients to swap fiat money at the same rate as they exchanged digital assets on systems outside of the bank, such as FTX.

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The bank's transition from traditional banking to a then-niche field mirrored a larger trend in the financial industry. Smaller American banks seeking to compete with larger rivals doubled down on areas traditionally avoided by finance in the hopes of giving them a fighting chance, but with varied results.

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"Anytime you go away from having a large portion of your business involve relationships on both sides of the balance sheet, you're going to get into difficulties," said Abbott Cooper, an activist investor who focuses on the banking sector. "And you're going to be in problems if you're not completely focused on the hazards that have been generated by it."

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Balance Sheet

Silvergate's collapse was partly aided by the peculiar nature of its financial sheet. Silvergate did not pay interest on the deposits it took from crypto customers, which meant it had a free pool of funds to invest in government debt and other equally liquid assets. Mortgage-backed securities and bonds issued by state and municipal governments were among the securities in its portfolio.

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This configuration, while not uncommon for any bank, proved problematic as the Federal Reserve raised interest rates, reducing the value of a portion of Silvergate's holdings. As the crypto market crashed and consumers hurried to withdraw funds, Silvergate's non-interest bearing deposits fell from $12 billion at the end of September to $3.9 billion at the end of last year, forcing the lender to sell securities to cover those withdrawals. Nevertheless, the bonds were worth less than the corporation paid for them, requiring it to sell them at a loss and causing a $1 billion hole in its earnings late last year.

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"They failed to understand that rising interest rates would have a significant impact on the volatility of those deposits," Todd Baker, a senior fellow at Columbia University's Richman Center for Commerce, Law, and Public Policy, told Bloomberg Television on March 2. "They also failed to recognize that if interest rates climbed, the value of their securities portfolio would drop."

FTX Dealings

Meanwhile, US authorities from the Justice Department's fraud division are investigating Silvergate's interactions with FTX and its trading subsidiary Alameda Research.

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Silvergate is being investigated for hosting accounts for Bankman-enterprises. Fried's The investigation raises an important question: What did banks and intermediaries working with Bankman-enterprises Fried's know about what US investigators have described as a multi-year plan to cheat investors and customers?

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The bank has not been charged with any wrongdoing, and the inquiry may conclude without charges being brought.

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Bankman-Fried is accused of engaging in a bank-fraud scheme that targeted a corporation named in court documents as "Bank 1," which is said to be situated in California. A person familiar with the case informed Bloomberg News that Bank 1 is Silvergate.

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Another critical point is how a financial institution investing so much in cryptocurrency did not elicit action from its authorities.

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"Where were the regulators on Silvergate? Jerry Comizio, an adjunct law professor at American University and a former US Treasury Department official, was asked. "They truly missed Silvergate."

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