Heading into this year, it seemed like deposits at crypto bank Silvergate Capital (SI 3.23%) might never stop growing. In the fourth quarter of 2020, Silvergate only had about $2.6 billion of deposits. Now, it has about $12 billion.
But this year, the bank has started to see outflows as cryptocurrencies have aggressively sold off and crypto interest has generally weakened.
Over the last two quarters, Silvergate has seen deposits from its digital asset clients, which are a big part of its business model, decline by $2.7 billion. Should investors be worried? Let's take a look.
Concerning but not entirely unexpected
Silvergate has developed a real-time payments system called the Silvergate Exchange Network (SEN) that enables crypto exchanges and institutional investors to trade in real time, which solves a pain point because much of the U.S. banking system doesn't operate at lightning speed.
Image source: Getty Images.
When customers are onboarded to SEN, they also open up a deposit account with Silvergate and typically bring a large amount of non-interest-bearing deposits to the bank, which the bank pays no interest on. These are the best kind of deposits a bank can have because they are essentially a free source of funding that the bank can simply deploy into higher-yielding assets like bonds and make a nice profit from the spread.
In the second quarter, deposits at Silvergate fell by about $900 million, but it wasn't a huge surprise because the price of Bitcoin and other cryptocurrencies had sold off intensely. Furthermore, volume on the SEN in Q2 still came in at a healthy $191 billion. But in the third quarter, another $1.8 billion in deposits left the bank, despite the price of Bitcoin being more stable.
Furthermore, SEN volume fell by close to 41% from the second quarter, despite the fact that Bitcoin and Ethereum trading volume increased versus Q2. Silvergate CEO Alan Lane said volume on the SEN took a hit due to a decline in the market caps of stablecoin issuers on the network. He also noted that less volatility in the price of Bitcoin led to fewer trading opportunities and therefore less volume on the SEN.
Lane added that "the drop in deposits is not surprising" due to "the drawdown in deposits, given the broader cryptocurrency bear market combined with the macro backdrop."
I definitely think it's more concerning to see heavier deposit outflows amid a calmer quarter for crypto, but given how quickly deposit balances swelled between the end of 2020 and now, some attrition is not entirely unexpected.
Crypto interest is still robust
While we might be in a crypto winter, I still think there is an overall strong interest in cryptocurrency and its long-term prospects.
Silvergate saw lower SEN volume and deposit outflows in the third quarter but the bank also managed to onboard 92 customers onto the SEN, which is more than the bank did in the fourth quarter of 2021. It is also more than the last quarter.
Furthermore, these newer clients brought a healthy amount of deposits to the bank. Chief Strategy Officer Ben Reynolds said that the new cohort of customers brought about $1 billion of deposits to the bank, and that number typically grows once they are fully onboarded. The pipeline for new SEN clients remains at more than 300 customers.
While I am of course concerned to see deposit outflows given how important deposits are to Silvergate's model, the trend was less worrisome to me after I took a step back. Some attrition was bound to happen, there has been lots of volatility with stablecoin issuers, and we are in a crypto winter right now.
Silvergate is still onboarding a lot of new customers who are bringing lots of deposits to the bank. Also, institutional interest in the crypto asset class continues to grow. Eventually, I do think the crypto winter will end and the price of Bitcoin will go higher. Silvergate should thrive in an environment like this because the company provides critical infrastructure to the crypto industry.
