There is a lot of debate over whether a cryptocurrency like Bitcoin (BTC 0.98%), with its finite supply of tokens, can be a hedge against inflation -- and I think the jury is still out on that one. But one crypto stock that I know can do that is Silvergate Capital (SI).
Silvergate Capital is a bank that has built a proprietary real-time payments system called the Silvergate Exchange Network (SEN) that enables institutional traders to instantly send and clear transactions to cryptocurrency exchanges or other parties on the network.
Because cryptocurrencies trade in real time and the U.S. payments system doesn't operate in real time, Silvergate has made the trading process easier for participating parties. The payments system has also created a company that will heavily benefit from rising interest rates. Here are two charts that explain why.
1. Excess cash and deposits
The great thing about SEN is that when traders, exchanges, and other parties are onboarded, they set up deposit accounts with the bank. These clients are hedge funds and asset managers that bring large sums of deposits that are not interest-bearing.
Because Silvergate was the first bank to bring a real-time payments platform to market, it has benefited from a first-mover advantage, and at the end of 2021, the bank had more than 1,380 clients. This fast client growth has enabled Silvergate to grow its balance sheet much faster than the typical bank.
SI cash and equivalents (quarterly). Data by YCharts.
At the end of 2021, Silvergate had accumulated nearly $14.3 billion of average deposits, up from $2.65 billion at the end of 2020. But the bank does not deploy much of these deposits into loans. In fact, Silvergate has only deployed about 12.5% of its deposits into loans. Nearly $5.4 billion of its deposits are in cash and $8.6 billion are in debt securities.
Image source: Getty Images.
2. Yields will increase
This brings me to my next chart, which shows just how little yield Silvergate was making on its securities and cash at the end of 2021.
Image source: Silvergate Capital Q4 presentation.
At the end of 2021, Silvergate only made 0.16% on all of its cash and just 1.11% on its securities book. That is practically nothing. By the very nature of the Federal Reserve recently raising its benchmark overnight lending rate to a range of 0.25% to 0.50%, Silvergate should be able to up its yield on cash into that range.
Furthermore, the yields on securities have also climbed a lot this year. The yield on the 10-year U.S. Treasury bill, just one of several fixed-income instruments in Silvergate's debt securities portfolio, has surged to 2.35%. At the end of 2021, that yield was only about 1.5%. So when its current securities mature, Silvergate will ideally be able to redeploy those deposits into much higher-yielding securities. I also wonder if management will be more aggressive in deploying cash into securities, considering the more attractive rates.
The most asset-sensitive bank around
I am curious to see if Silvergate sees any deposit or liquidity outflows in a rising-rate environment, but the crypto ecosystem is large and is getting more ingrained into the traditional financial ecosystem every day. Plus, there are still only a few banks that offer payments systems like SEN, so I expect Silvergate to keep adding deposits on a net basis as it continues to grow clients. These deposits, as you can see in the chart above, don't really cost the bank anything.
So with the federal funds rate rising and debt securities also paying out more yield right now, the bank should be able to significantly grow its profits without having to do that much.
In its annual filing, Silvergate estimates that a 1% rise in the federal funds rate would increase net interest income on loans, securities, and cash by nearly 60% over the next year. Despite the fact that most banks benefit from rising rates, that kind of sensitivity is simply unheard of.
