A lot of retail investors interested in the crypto space focus on the cryptocurrencies themselves, like Bitcoin and Ethereum, or on bitcoin mining companies. But a lot of these investors are missing the burgeoning crypto opportunity in what many often deem as the boring banking space. The crypto banking space enables many institutional crypto traders and crypto exchanges to more efficiently conduct transactions, and helps other crypto businesses like miners get more capital efficient.
While there are not a ton of crypto banks right now, the two main ones are the roughly $12 billion asset Silvergate Capital (SI 2.50%) based in La Jolla, California, and the much larger Signature Bank (SBNY) based in New York with nearly $108 billion in assets. Let's compare the two and look at which one is the better investment.
Real-time payments
Silvergate and Signature, despite their different sizes, are somewhat similar in their innovation in that both banks have developed a real-time payments system that allows parties on the network to conduct transactions instantly, at any time of the day or week. Silvergate's system is called the Silvergate Exchange Network (SEN), while Signature's is called Signet. The U.S. banking system does not operate on a real-time payments system, while cryptocurrencies trade at all times, so these platforms are helpful for those trading cryptocurrencies.
Silvergate has more clients and transaction flow on SEN. At the end of the third quarter, the bank reported that it had more than 1,300 clients and SEN utilization reached nearly $240 billion in Q2 before dipping to $162 billion at the end of Q3, along with the decline in crypto spot trading in the quarter. Signature COO Eric Howell said on the bank's Q3 earnings call said that volume on Signet was $149 billion in Q2 and then fell to $128 billion in Q3.In Q2, Howell said the bank had 812 clients on Signet.
Image source: Getty Images.
It also looks like Silvergate has a better deposit base. With Signature being a bigger bank with more legacy operations, it is paying more on its overall deposit base than Silvergate. But even drilling down to the deposits brought in by SEN and Signet, SEN appears to have the edge with nearly all of its deposits from digital asset customers and the cost of overall funding at practically zero. Signature CEO Joseph DePaolo said about 30% of deposits from its digital asset team are non-interest bearing, while the bank pays a very small amount of interest on 70% of those deposits. Signature still brings in a strong deposit base, but I'd give Silvergate the edge for deposits, an important metric that bank investors watch.
Differences in the top line
Because Silvergate and Signature are such strong deposit growers, the problem for both banks -- and it's a good problem to have -- is how to deploy those deposits effectively and generate revenue. Both banks turn good profits, but Signature looks to have better lending operations. Signature has a loan-to-deposit ratio of more than 61%, meaning it has been able to deploy 61% of its deposits into loans. It's been able to do this with a fund banking and venture banking team, which is largely in the business of making short-term loans to venture capital firms. I love this line of business because it's really niche, very safe, presents lots of cross-selling opportunities, and has actually generated strong loan growth over the past year, which is rare. Signature is also in the process of rolling out U.S. Small Business Administration (SBA) and mortgage warehouse lending teams, which I expect to contribute nicely to loan growth in the future.
Silvergate, on the other hand, has a much smaller lending operation right now. The bank's loan-to-deposit ratio has fallen to less than 14%, and all of its loans will eventually be either comprised of mortgage warehouse, lines of credit provided to mortgage originators, or a new product called SEN Leverage, which is a line of credit in U.S. dollars collateralized by Bitcoin. The bank is in the process of winding down its commercial real estate and residential mortgage portfolios. SEN Leverage is a very promising product, although it's a bit unclear how regulation might impact it down the line. Signature has the ability to do loans similar to Silvergate's Leverage, but management has indicated that it is not interested in doing a lot of these loans right now.
On the other big top-line contributor, fee income, Silvergate appears to have the edge right now. Both Signet and SEN bring lots of new customers to the bank that may take advantage of other more traditional banking products and services. In Q3, Silvergate derived roughly 27% of its total revenue from fee income, while Signature did about 6%.
Which is the better investment?
Any way you slice it, the market has awarded Silvergate with the premium valuation, whether it's a higher price-to-tangible book ratio or higher earnings multiple.
SBNY Price to Tangible Book Value data by YCharts
I think both of these banks are good investments as crypto banking is a great industry right now. In my view, Signature is a safer investment because of its more traditional and diverse lending segments, which are not tied to Bitcoin. The venture banking, mortgage warehouse, and SBA lending units can deliver attractive yield and volume and will help the bank absorb the excess liquidity better.
But Silvergate looks to be the higher-growth opportunity long term. It appears to have the first-mover advantage with the higher volume being processed and more clients on SEN. And while both banks are working in the stablecoin arena, Silvergate is going to be the exclusive issuer of Facebook's Diem U.S. dollar-pegged stablecoin, which could be huge. With less than a $4 billion market capitalization, Silvergate could also be an acquisition candidate as well, not that I think it would be interested right now with how promising the future looks. There's more regulatory risk at Silvergate, due to how much the bank is leaning into SEN Leverage and with stablecoin regulation still unclear. I would also like to see more diverse lending at Silvergate, but ultimately Silvergate has the ability to grow very fast and into something very special.
