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These Banks Were Left Holding the Bag in Crypto Implosion

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Banks go where the money is. So it stands to reason that they may be left with a sack if the market stretches too far and then collapses.

Crypto is no exception. While the big banks have shied away from what Jamie Dimon called “decentralized Ponzi schemes,” many smaller lenders continue to serve companies operating in fledgling sectors. We expected a niche revenue that would help us. They include Silvergate Capital Corporation, Provident Bancorp Inc., Metropolitan Commercial Bank, Signature Bank, Customer Bancorp Inc. and others. His recent demise of FTX has put their business in the spotlight.

Silvergate’s relationship with cryptocurrencies dates back to the early days of digital currencies, when the market was largely limited to Bitcoin. The chief executive, he said, was an early believer in Alan Lane and wanted to create a product that would serve the market. “What I saw was an opportunity to bank on these companies that were essentially taking the risk out of other banks,” he says.

Identifying the disconnect between the 24/7 trading cycle of cryptocurrencies and the 9-to-5 five-day-a-week clock of traditional banks, Lane draws a line between the world of dollars and the world of cryptocurrencies. I have set up a payment network that provides an interface. His Silvergate Exchange Network (SEN) allows users to move dollars between them, so they can settle fiat currency for cryptocurrency transactions at any time of the day or night. The network is used by many of the major cryptocurrency players, with cumulative payouts surpassing his $1 trillion earlier this year. One of his customers was his FTX, the now infamous founder of which Sam Bankman-Fried was a fan.

“Life as a cryptocurrency company can be divided into pre-Silvergate and post-Silvergate,” he said. “It is hard to overstate how much we have revolutionized banking for blockchain companies.”

Silvergate profited from deposits left on the network by digital asset customers. At the end of September, these deposits accounted for 90% of the bank’s total deposit base, amounting to $11.9 billion. Banks reinvested them in securities to earn a margin. A $11.4 billion portfolio of securities gave him a spread of 2.2% in the three months to September.

The problem now is that not only is FTX gone, but other customers have left as well. Silvergate revealed that FTX is less than 10% of his deposits from digital asset customers. It was later revealed that the quarter-to-date average deposits he had dropped to $9.8 billion. On Friday, cryptocurrency trading platform FalconX sent an email to its customers stating, “I will not be using his SEN and wire in Silvergate.Effective immediately and until further notice.”

In order to honor withdrawals, Silvergate must utilize its portfolio of securities to raise cash. However, rising interest rates have eroded the value of that portfolio. Banks already had $1 billion in unrealized losses at the end of September. In addition, a portion of the portfolio ($3.1 billion) is in held-to-maturity sleeves, which accounting standards prohibit touching. Silvergate’s market value has gone from around $200 million in early 2020 to a peak in 2021 when he’s over $4 billion and below $1 billion.

Provident has a different kind of exposure to crypto. Founded in 1828, he is one of the oldest banks in the United States and has operated for most of its history as a depositor-owned mutual holding company. In 2019, the bank was demutualized into a stock holding company and the capital became very large as new shares were issued in the conversion process. Looking for a way to invest their surplus capital, banks stumbled upon cryptocurrencies. It first launched a deposit and cash management service for digital currency customers, and in late 2020 it also launched lending. “Old banks are boring,” the company said in an investor presentation.

Provident provided financing to support crypto-backed lending, margin trading, and crypto mining operations. Increased crypto lending to up to $139 million by mid-2022. This corresponds to 58% of equity capital. However, the collapse of the digital asset market has made recovery of some of these loans difficult. The bank delayed its third quarter earnings report to confirm these loans. This shows that the loss due to the impairment of the $104 million crypto mining loan could reach his $27.5 million.

Several other smaller banks have been exposed to crypto. New York-based Metropolitan Commercial Bank has processed his $1.5 billion deposit from its digital currency business at the end of 2021. This represents about a quarter of total deposits. One of the company’s major customers is Voyager Digital, whose bankruptcy filing in July required Metropolitan Commercial Bank to return deposits to end-users. By the end of September, deposits from digital companies had halved.

For now, some banks claim their cryptocurrency business is resilient. Signature Bank, also based in New York, has been accepting deposits related to digital assets since 2018 and launched a payment network like Silvergate in 2019. It used to offer loans backed by certain types of cryptocurrencies that are no longer in the market. As of the end of September, Signature Bank had $23.5 billion in digital asset deposits on its balance sheet, about a quarter of its total deposits. About $12.3 billion of the total comes from exchanges, of which FTX accounts for a small percentage. Last week, the bank informed investors that their balances were stable.

West Reading, Pennsylvania client Bancorp also said its balances are stable so far. We operate a blockchain-based instant payment system using our own unlisted token CBIT. His deposit balance last week was $1.85 billion compared to his $1.9 billion at the end of September.

Bank compliance procedures will no doubt come under greater scrutiny. Sam Bankman-Fried suggests that the money transfer for FTX may have been directed to sister company Alameda Research. FTX’s new CEO, who was tasked with overseeing the bankruptcy, said he had never seen “the complete failure of corporate management and the complete lack of reliable financial information that happened here.”

All of this raises new issues facing banks that have traded with FTX. Did you know your customer?

Bloomberg Opinion Details:

• Will a unicorn like FTX be the next ‘big short’?: Chris Bryant

• Crypto Retreat’s Quantum Leap for Central Banks: Andy Mukherjee

• FTX hammers more nails into the crypto coffin: Lionel Laurent

This column does not necessarily reflect the opinions of the editorial board or Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is the author of the weekly financial newsletter Net Interest.

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