When looking for powerful growth stocks, investors must consider several relevant questions. Is the company gaining market share? Is it innovating with its products and services? Is it a first-mover in a whole new industry?
One company that answers "yes" to all three questions is Silvergate Capital (SI 9.96%). Silvergate is a bank that focuses on cryptocurrency customers. Among its many advantages, Silvergate was one of the first movers in this space, working with Bitcoin (BTC 0.30%) when it was still trading at around $100 a token.
As cryptocurrencies have taken off, so has Silvergate's business. Since going public in late 2019, Silvergate has seen its stock price rocket 1,100% higher. Such a huge run-up may give investors the impression the stock is expensive and that it's too late to get in. But that's not the case. Here's why.
Silvergate started was an early mover in the cryptocurrency market
Silvergate began focusing on cryptocurrency before anyone else was paying attention. Now it's a powerful growth stock. The bank took a risk in 2013 when it began pursuing crypto customers. At the time, Bitcoin was still relatively new (it was created in 2009). The regulatory regime was complex and underdeveloped, and many cryptocurrency-based companies had a difficult time navigating these regulations. So Silvergate stepped up to the plate.
Silvergate helped those early customers by providing exchanges with the infrastructure needed to support the most basic financial elements, like fund transfers, customer account controls, and other security measures.
Over time, Silvergate's solutions have evolved to address more specific needs. A few years ago, Silvergate introduced its Silvergate Exchange Network (SEN). SEN is a payments network for those in the crypto space, allowing customers to transfer U.S. dollars between various crypto exchanges regardless of the type of exchange. Customers using SEN include major exchanges like Coinbase and Binance. Creating SEN has enabled Silvergate to significantly grow non-interest-bearing deposits, which have provided most of the company's funding in the past few years. Since 2020, the company has grown its digital currency deposits by nearly 500%.
Silvergate has few direct competitors. One competing bank is Signature Bank, (SBNY 5.32%) which offers a similar product as the SEN called Signet. However, Silvergate has more clients and transactions on its network, with a volume of $162 billion compared to Signature's $128 billion in the third quarter.
Revenue has grown but fluctuates with cryptocurrency prices
In the third quarter, SEN handled $162 billion in U.S. dollar transfers, up 346% from the same quarter last year but down 32% from the second quarter. Silvergate pulled in $8.1 million in transaction revenue -- fee income it earned from its crypto customers in Q3. While this is up significantly from last year's Q3 total of $3.3 million, it's down from Q2's $11.3 million. This transaction volume has a strong relationship with Bitcoin and Ethereum's trading volumes, which decreased 43% compared to Q2.
A newer product built on SEN is called SEN Leverage. Institutional investors can enter into an agreement with Silvergate to get U.S. dollar financing, using Bitcoin as collateral against that loan. CEO Alan Lane has said that its customers were asking the bank to create something that would give them more "capital efficiency." This simply means that SEN Leverage offers institutional customers access to more trading capital by providing leverage on their Bitcoin. While getting leverage on Bitcoin isn't new, it is new for a chartered bank to help facilitate things. The product has seen lots of interest, and in Q3, total SEN Leverage commitments totaled $322.5 million, up 25% from Q2 and up 808% from last year's Q3.
However, it doesn't come without risk. If the price of Bitcoin were to fall, the bank would need to sell off those customers' collateral to cover the loan. Since Bitcoin is open 24/7 it can quickly sell off this Bitcoin. At this point, the bank said it hasn't had any issues with the product.
Management was especially pleased with how the product performed in the quarter despite the lower trading volumes. Lane said, "[W]e couldn't be more excited about where SEN Leverage is headed for the future" -- and for good reason. On Oct. 1, the company announced it would provide Marathon Digital Holdings with a $100 million line of credit, opening up another potential customer base of Bitcoin miners that could use the product to obtain funding while still keeping Bitcoin on their own balance sheet. Not only that, but competitor Signature Bank doesn't yet have a product like Silvergate's SEN Leverage -- helping Silvergate gobble up market share in an untapped market for banks.
While Silvergate is seeing good growth in SEN and SEN Leverage products, it will still see earnings fluctuate as the prices of Bitcoin and Ethereum move. CEO Alan Lane recognized that Silvergate is highly correlated with the price of Bitcoin. However, he noted that as the bank adds more products and services, its earnings should become less correlated with the price of those cryptocurrencies.
A growth stock to add over time
According to a study by Allied Market Research, the global cryptocurrency market will more than triple by 2030 to nearly $5 trillion. This would suggest a compound annual growth rate of 12.8% over that time period. Growth in the crypto industry would bode well for Silvergate capital, opening up even more opportunities to innovate as the space grows.
Investors have noted this growth potential and, as a result, Silvergate stock currently trades at a rich valuation, with a price-to-earnings (P/E) of 81 while its price-to-sales (P/S) ratio is 46. While the stock is positioned well for more growth ahead, it is also subject to a lot of the volatility seen in the cryptocurrency space.
Despite management's work at breaking the correlation between Bitcoin's price and the bank's profits, Silvergate could be still be subjected to dramatic price swings as the price of Bitcoin fluctuates. Bitcoin has had multiple 50% declines over the past five years, and it's not impossible for this to happen again. So while Silvergate is still early on its growth journey, I think the volatility in cryptocurrency prices is a great reason for investors to use dollar-cost averaging to buy into this stock.
By using dollar-cost averaging, you can gradually build your stock position in Silvergate Capital, smoothing out the average price paid for your stock over time while reducing the emotional stress that can come with investing in growth stocks.