In the past year we have witnessed an explosion of institutional support for Bitcoin and other cryptocurrencies. Major companies like Square and PayPal Holdings have embraced Bitcoin. Even legacy institutions like JPMorgan Chase and Goldman Sachs are considering adopting cryptocurrencies after years of skepticism. After all, it was only three short years ago that JPMorgan Chase CEO Jamie Dimon called Bitcoin a "fraud" and "worse than tulip bulbs."
The meteoric rise in Bitcoin is hard to ignore. In the past year alone, the cryptocurrency has risen more than 800%, from around $6,800 to over $62,000 as of Tuesday evening.
One company that has been involved in the space for almost eight years now is Silvergate Capital (SI 2.50%), a California-chartered commercial bank. In 2013, the bank shifted its business model away from traditional banking services to focus more on digital currency customers. That focus has paid off, with the bank's stock up an astonishing 1,500% in the past year alone. With its promising start and an impressive gain in share price, is Silvergate Capital the growth stock for you?
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An early mover in the digital currency space
2013 was the Wild West of cryptocurrencies. The implications of digital currencies were complex and the regulatory regime was underdeveloped -- and, frankly, a big question mark. Amid regulatory uncertainty, those in the space had a hard time finding a reliable financial services partner. Seeing an opportunity in a new and unknown market, Silvergate Capital dove in head first.
The bank saw an opportunity in digital currencies. Specifically, it saw a growing industry that could use better infrastructure that would allow for the transfer of funds, provide account controls for customers, and provide other security measures, too. Silvergate believed that in order for digital currencies to gain widespread acceptance, it was necessary to have an infrastructure in place for these financial services.
The bank put in serious work from there, and spent years in the digital space understanding the needs of customers. This ultimately led to the creation of the Silvergate Exchange Network (SEN) in 2017, a payments network for those in the digital currency space, which also serves as a platform for developers to create new products and services. The SEN is available 24/7 and enables quick and efficient transfer of U.S. dollars between its customers regardless of the exchange they use.
Gaining a network effect from a first-mover position
As one of the earliest adopters in digital currencies, Silvergate has a first-mover advantage. It has been building its SEN since 2017, long before larger institutions even considered touching Bitcoin. As a result, it built up a large customer base that includes some of the biggest names in cryptocurrency. Its SEN includes exchanges like Coinbase, Binance, Gemini, and Bitstamp as just a few of its 76 digital currency exchange customers. The company also has over 600 institutional investors on board as customers and another 286 customers that work in different areas of development on the SEN, developing things like protocols, platforms, and mining operations.
The company has built up its network of customers, with its digital currency customer base growing at a 58% compound annual growth rate (CAGR) since 2017. This has helped it grow its transaction revenue at a 196% CAGR during that same time period, posting $11.1 million in transaction revenue in 2020. As the company continues to grow its customer base, network effects will only make its SEN even more powerful and influential. The strengthening network on the SEN gives Silvergate a strong competitive advantage over rivals who weren't as quick to jump on the trend.
Continued adoption of cryptocurrencies will serve as a tailwind
Silvergate is laser-focused on growing its non-interest-bearing deposits. While it still generates revenue from a conservative portfolio of cash, short-term securities, and certain types of loans, the bank is generating an increasing amount of revenue from non-interest fees.
In 2020, the bank saw deposit related fees from digital currency customers increase $6.2 million, to $11.1 million for the year, a 126% growth in fees compared to the year before. It also saw non-interest-bearing deposits jump from $3.8 billion in 2019 to $5.1 billion in 2020, representing 98% of its total deposits. With almost all accounts being non-interest-bearing, it's no surprise that Silvergate's cost of deposits is a mere 0.01% in the fourth quarter.
Continued innovation with SEN Leverage
While Silvergate Capital's first-mover advantage has helped it build an economic moat, management isn't getting complacent. In early 2020, the company introduced SEN Leverage, which lets institutional investors enter into a loan agreement with Silvergate Bank for USD financing. Silvergate uses this with its SEN to fund loans while the investor's collateral -- Bitcoin -- is held by a custodian in a separate, cold storage account.
The product launched in January 2020, but it didn't become a full offering until the fourth quarter of last year. During the fourth quarter, it saw volume of $82.5 million in its SEN Leverage product, up from $35.5 million in the quarter that preceded it.
This impressive growth is expected to continue into 2021. The company recently announced partnerships with Fidelity Digital Assets and Coinbase to act as custodians for SEN Leverage. Giving customers the ability to use Bitcoin as collateral for taking out loans shows just how far the digital financial infrastructure has come, with Silvergate Capital leading the way.
A great play for the rise of digital assets
Silvergate Capital has done a tremendous job of capitalizing on the move to digital currencies. It was one of the first movers in 2013, and continues to expand product offerings, with SEN in 2017 and SEN Leverage in 2020, showing its strong commitment to building out the financial services infrastructure around digital currencies.
The stock is trading at a price-to-earnings ratio of 122, showing the lofty long-term expectations investors have for this stock. However, its first-mover advantage combined with network effects that grow stronger as new customers join could make this high-flying stock worth its lofty valuation, and a tremendous stock to buy and hold for the next decade.
