In May, Silvergate Capital (SI -20.00%), a bank that operates in the cryptocurrency space, struck a blockbuster partnership with Facebook to become the exclusive issuer of the Diem U.S. dollar stablecoin, formerly known as Facebook's Libra project. Not only will Silvergate become the exclusive issuer of the Diem, but it will also manage the Diem reserve. Management has expressed a lot of excitement about the potential for stablecoins. Let's take a look at how Silvergate is positioned to drive revenue from stablecoins and its partnership with Facebook.
Monetizing stablecoins
Stablecoins are digital assets that are backed by another, ideally more stable, asset such as the U.S. dollar, or maybe a commodity like gold. The goal of stablecoins is to take advantage of certain characteristics of digital assets, such as the ability to be exchanged easily without a bank account. But as their name suggests, stablecoins are supposed to come with less risk and volatility than pure cryptocurrencies like Bitcoin.
Silvergate is an ideal partner to issue stablecoins because its has built its own in-house payments system called the Silvergate Exchange Network (SEN). SEN can clear transactions in U.S. dollars in real time around the clock, 365 days a year, between any two users in the network. This is ideal for institutional crypto traders and crypto exchanges because cryptocurrencies trade around the clock. SEN already provides each of the four regulated U.S. stablecoin issuers with critical infrastructure to operate.
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But the U.S. dollar Diem stablecoin could be a game changer for Silvergate because Facebook brings a massive audience with it. The social media giant has 2.8 billion global users, and if it can convince a small portion of that audience to purchase a small amount of Diem stablecoins, it could quickly amass a big share of the market. On Silvergate's recent earnings call, the bank's management team said it sees a lot of use cases for stablecoins, including for commerce between consumers and merchants as well as for cross-border payments.
Silvergate CEO Alan Lane recently outlined three ways the bank can monetize stablecoins: transaction fees on the minting and burning of the stablecoins; yield on the reserve deposits that back the stablecoin (and which Silvergate will manage); and a new customer segment that Silvergate can sell traditional banking services to.
The reserve deposits from the stablecoins could significantly grow deposits at the bank, which are already growing extremely fast, and management said it will need to manage the reserve deposits in a "capital-efficient manner." The bank will also have to share some of its fees with Facebook, but it should still be a major source of revenue. Lane said he sees stablecoins as the next big thing for Silvergate.
An exciting time
It's an exciting time for Silvergate. The company just had an excellent second quarter of earnings, despite the drop in the price of Bitcoin and no revenue yet from stablecoins. The bank is currently working on building out the infrastructure to support the minting and burning of stablecoins. While the timing of the project is still hard to predict, Lane said management would be disappointed if it wasn't able to roll out the pilot before the end of the year. So watch this project closely, as it could be a major driver of revenue for the bank in the not-too-distant future and on a long-term basis.
