Crypto bank Silvergate Capital (SI) will report earnings on July 19, and investors will be interested to get a look under the hood after what has been a very difficult quarter for cryptocurrencies. Crypto prices have slumped all year, and trading volume is down as well. While investors will have a lot of questions regarding the quarter, here is the most important thing I'm watching.
It's all about the deposits
Silvergate Capital has built a real-time payments system to better facilitate crypto trading between institutional investors and crypto exchanges. Because cryptocurrencies trade around the clock but the U.S. banking system doesn't operate in real time, Silvergate's platform, the Silvergate Exchange Network (SEN), is very appealing for crypto traders.
But Silvergate doesn't earn revenue by charging investors to join the platform. Rather, it benefits from digital-asset customers moving large sums of non-interest-bearing deposits into its custody. Because Silvergate doesn't have to pay out any interest on these assets to users, it can instead deploy them into interest-earning assets.
Based on its own reporting, Silvergate Capital has grown average deposits from $6.4 billion in the first quarter of 2021 to nearly $15 billion at the end of the first quarter of this year. Non-interest-bearing deposits are also the highest-quality deposits a bank can gather. This has made Silvergate Capital incredibly asset sensitive, meaning it benefits tremendously from rising interest rates.
The bank estimated on its last quarterly regulatory filing that a 1% move in the federal funds rate would grow net interest income -- the profit banks make on loans, securities, and cash after funding those assets -- by close to 31.5% over the next year. This makes Silvergate the most asset-sensitive bank that I know of. The federal funds rate started the year at practically zero and could end 2022 at 3% or higher.
But after an intense crypto sell-off and much lower crypto trading activity, investors may be wondering whether there will be as much interest in SEN or if investors might leave the platform, taking their valuable assets with them. While the bank has an overall correlation to the price of Bitcoin (BTC 0.10%) and the crypto market, its profits depend on its deposit base. If the deposit base shrinks significantly, that would be very detrimental to its earnings.
Bank of America analyst Brandon Berman recently said that average deposits from Silvergate's digital currency business have a 93% correlation to the quarterly change in the price of Bitcoin, average Bitcoin price volatility, and the quarterly change in trading volume. During the end of Q1, the price of Bitcoin fell from $45,528 to below $20,000, and crypto spot trading volume has been lower in the second quarter of 2022 than the first, although not significantly lower. Berman said he expects to see the bank's average deposits anywhere from 10% higher to 10% lower from the first quarter.
In the first quarter of 2022, Silvergate added $1.4 billion of average deposits. When asked in April about deposit trends and deposit costs, CEO Alan Lane said the bank encourages customers looking for yield on their deposits to take them to another bank. "And therefore, we don't see a time when we will pay interest on these deposits," Lane added, suggesting the bank was not terribly worried about deposit outflows at the time.
What would be a good sign?
It would be great if Silvergate could show some deposit growth, even if it's modest because of what a tough quarter it was for crypto. The goal, in my mind, is to see growing crypto adoption and more investors entering the space. Who knows, maybe some new investors are even taking this opportunity to buy the dip? I also hope to see Silvergate's pipeline of SEN clients remain robust.
As long as Silvergate shows it's still playing a big role in crypto adoption and trading, and continuing to attract interest from new clients, I think the bank has a very bright future.