In 2021, the crypto bank Silvergate Capital (SI 19.97%) announced a blockbuster partnership with Meta Platforms (formerly Facebook) to become the exclusive issuer of the social media giant's planned U.S. dollar-backed stablecoin, Diem. Stablecoins are digital assets pegged to a currency or commodity. Now, however, Silvergate has announced that it plans to acquire the technology assets of Diem for $182 million in a cash-stock deal, with plans to integrate the technology into Silvergate's existing platform. Let's take a look at where things now stand with Diem and Silvergate's stablecoin ambitions.
Losing Meta as a partner
Silvergate Capital is a bank, but its business is driven by its real-time proprietary payments system called the Silvergate Exchange Network (SEN), which enables multiple parties on the network to instantly clear and settle transactions at any time. The network's main use right now is to better facilitate cryptocurrency trading between institutional traders and crypto exchanges because the U.S. doesn't currently operate on a real-time payments system, while cryptocurrencies never stop trading.
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But Silvergate also wants to use SEN to mint and burn stablecoins for commerce and remittance purposes. The partnership with Meta on Diem appeared to be a massive opportunity, largely because Meta's audience is global and it has billions of users, so even a small adoption could have been huge. Silvergate's Chief Executive Officer Alan Lane has said that the bank can make money on stablecoins from transaction fees for minting and burning the digital assets (burning is the crypto equivalent of stock buybacks), from yield on the reserve deposits that back the stablecoins, and from new customers it brings in from stablecoins to whom it can then sell other traditional banking services and products.
At an initial glance, the acquisition of Diem certainly looks positive. In the news release, Siliverage said the assets acquired were "built by a world-class group of engineers" and "include development, deployment and operations infrastructure and tools for running a blockchain-based payment network designed to facilitate payments for commerce and cross-border remittances." The acquisition also includes proprietary software. Still, without Meta, Silvergate does lose a powerful distribution partner. The bank will no longer have this big established brand backing a stablecoin and pushing it out to billions of its users.
A good sign
The acquisition of Diem definitely means that Silvergate has every intention of pressing on with its plan to issue a U.S. dollar stablecoin. The release said Diem "has been operating in a pre-launch phase." On the bank's latest earnings call, Lane said, "... we would expect that the distribution for that stablecoin would largely happen through our existing customers as well as new potential customers that have retail distribution."
Meta, meanwhile, seems to have abandoned plans for Diem due to regulatory issues. As a licensed bank, Silvergate probably is in a better position to bring Diem to market. In fact, Meta apparently made the decision to partner with Silvergate to appease regulators. Silvergate also got some good news on the regulatory front when the President's Working Group on Financial Markets last November issued a series of recommendations that said it thought stablecoins should be issued by licensed banks. Lane also said the bank updated its application with the New York Department of Financial Services to form a limited purpose trust company, which would be used to help manage the reserve deposits associated with stablecoins.
Furthermore, many investors have been nervous that the Federal Reserve may launch a central bank digital coin (CBDC), which would essentially be in competition with Silvergate. But a recent paper from the Fed indicated that a CBDC is still likely years away. Lane said the bank hopes to launch something this year.
Management seems to be heavily investing in its stablecoin efforts. Aside from the purchase of the Diem assets, expenses related to salaries and benefits jumped nearly $3 million in Q4 of 2021, which management attributed to the "deliberate investments" for strategic growth including the development of stablecoin infrastructure.
No stablecoin is certain
Although it is now clear that Silvergate has every intention of introducing a U.S. dollar-backed stablecoin, I still think success is far from certain. With all of its resources, Meta couldn't get it done. There also could still be regulatory issues, while management has gotten vaguer on a launch date. So I would still caution investors on putting too much weight on the stablecoin initiative in terms of thinking about its revenue because there is still a lot that could go wrong. The bank's core business on SEN is still performing very well, so any kind of stablecoin pilot this year would be a bonus.
