In general, most bank stocks have declined this year. But for the $2.6 billion financial firm Silvergate Capital (NYSE:SI), based in La Jolla, California, it has been a completely different story.

The bank conducted its initial public offering at the end of 2019 and for much of its public life traded between $13 and $16 per share. But at the end of September, the bank's stock surged and (as of Dec. 9) trades for more than $40 per share. The stock has appreciated close to 200% in less than three months.

Let's meet this relative newcomer to the public markets, and see what is driving the sharp increase in its stock price.

The crypto bank 

There aren't too many banks that really understand cryptocurrencies, but Silvergate is certainly one of them. The bank has actually been around for a while, but several years ago foresaw that cryptocurrencies such as bitcoin would one day be an investable asset.

A digital bitcoin token on a black background.

Image source: Getty Images.

As a result, the bank created its own digital currency payments system called the Silvergate Exchange Network (SEN). SEN essentially serves as the middleman between digital currency exchanges like Coinbase and institutional investors looking to trade crypto assets. The advantage is that SEN is a real-time payments network, meaning it can clear transfers instantly around the clock, 365 days a year. If you are using a normal bank to connect to a crypto exchange, transfers are only cleared during normal banking hours, which is not ideal for crypto assets that trade constantly. In October, SEN surpassed $100 billion in lifetime transfer volume.

Silvergate Exchange Network

Image source: Silvergate Capital

SEN has been great for the bank because it has allowed the company to bring in tons of non-interest-bearing deposits, which are those that the bank doesn't have to pay any interest on. That ultimately helps boost the bank's overall margin. At the end of the third quarter, non-interest-bearing deposits made up 95% of Silvergate's total deposits. To say that is absolutely outstanding would actually be a huge understatement. Most banks are happy to get 30% of total deposits from non-interest-bearing sources. Silvergate's cost of deposits at the end of the third quarter was only 0.01%, which is again incredible even in this ultra-low interest-rate environment.

SEN also helps drive non-interest income through deposit fees on its digital currency customers. Non-interest income at the bank in the third quarter made up 17% of total revenue, which is very good for a bank as small as Silvergate.

Silvergate also recently completed a pilot program on another interesting crypto product called SEN Leverage. SEN Leverage is a commercial and industrial product that allows customers to obtain a loan in U.S. dollars that is collateralized by bitcoin. These are very attractive because bitcoin is an extremely liquid form of collateral being traded 24 hours a day, 365 days per year, and is therefore much easier to liquidate than other forms of collateral (like a house, for instance).

A few things to know

The performance of the stock seems to be at least partially linked to the performance of bitcoin. If you look at the price charts for bitcoin and Silvergate, both the price of bitcoin and Silvergate's stock started to shoot up at the end of September. Silvergate's CEO Alan Lane said on the company's third-quarter earnings call that the strong appreciation of bitcoin and active trading environment led to more transactions on SEN. 

Also, there is competition in the space, with JPMorgan Chase, the country's largest bank, recently rolling out products that will commercialize digital currencies. And there is only likely to be more competition as digital currencies become more mainstream. Lane said on the third-quarter earnings call that he is not overly worried because many crypto exchanges want to have multiple banking partners. Also, as the network at SEN gets bigger, that will only drive more non-interest income and low-cost deposits. With a very strong head start over its peers, Silvergate seems well-positioned to succeed in a competitive environment.

There could be volatility

Considering the huge price appreciation in bitcoin over the past few months, I would expect the bank to turn in strong fourth-quarter earnings because there has probably been a lot of transaction volume over the SEN.

While this is clearly a strong-performing bank in an exciting industry, the bank did just experience huge growth, and is now trading around 270% over book value as of this writing, so it could be a bit volatile going forward. But if there is a dip and an opportunity to buy the stock at a lower valuation, I would definitely recommend doing so.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.