When major crypto exchange FTX filed for bankruptcy in November, it was just one of several crypto-related companies going under in the past year. But FTX was one of the most prominent players in the space, and its collapse led to a crisis of confidence in cryptocurrencies.
These events sparked a run on the bank Silvergate Capital (SI 1.63%), which caters to digital currency customers. Silvergate has faced scrutiny for its relationship with FTX, and the stock dropped from $50 on Nov. 8, 2022, to $22 on Jan. 4, 2023.
When the bank announced preliminary fourth-quarter results last week, investors discovered that things were far worse than feared. Deposits at the bank had plummeted, and the stock fell another 43% overnight. So let's see where Silvergate could go from here.
OTC: SI
Key Data Points
Silvergate's deposit base shrank by nearly 70% in a matter of months
Silvergate Capital provides banking services for cryptocurrency customers. In 2013 the bank saw an opportunity to help customers navigate uncertainty in the nascent cryptocurrency space.
Its earliest product was the Silvergate Exchange Network (SEN), which allows cryptocurrency exchanges like Coinbase, Binance, and the now-bankrupt FTX to transfer U.S. dollars between one another quickly and efficiently. The bank enjoyed massive growth as the price of Bitcoin exploded to over $65,000 in 2021. From 2019 to 2021, Silvergate's total deposits mushroomed from $1.8 billion to $14.3 billion.
Things began to turn in early 2022 when significant leverage in the crypto space began to unwind. Terra, a blockchain designed to facilitate stablecoins, was the first to experience trouble back in May when a series of significant withdrawals sent its Luna token plummeting. The collapse of the Three Arrows Capital hedge fund followed, along with Celsius and Voyager -- all of which have filed for bankruptcy.
Silvergate weathered these events, and at the end of the third quarter, the bank still had $11.9 billion in deposits from its crypto. After that, however, the fears about contagion spreading from FTX to others caused a panic. Customers began pulling funds from crypto en masse, resulting in a massive drop in deposits for Silvergate Capital. In its Jan. 5 release, Silvergate announced its deposits from digital asset customers had fallen by $3.8 billion, or 68%, from the previous quarter.
The bank had to sell debt securities to shore up its balance sheet
With such a dramatic drop in deposits, Silvergate took steps to ensure it had enough capital for future deposit outflows. The bank sold $5.2 billion worth of debt securities to raise cash, resulting in a loss of $718 million. It currently has cash and cash equivalents of $4.6 billion -- giving it more than enough capital above its total deposits of $3.8 billion. It's also holding another $5.6 billion in debt securities and will likely sell more to pay down its wholesale borrowings, which could result in an additional $300 million in losses.
The bank also wrote down the Diem stablecoin assets it bought back in 2022 from Meta Platforms, resulting in a $196 million impairment charge. This write-down is based on the belief that its blockchain-based solution won't be coming out anytime soon as it deals with its current situation.
Here's what's next for Silvergate
Along with shoring up its balance sheet, Silvergate is preparing for what it says will be a "sustained period of transformation." As part of this transformation, it is cutting expenses and has laid off 200 employees, or about 40% of its workforce. It's also "evaluating its product portfolio and customer relationships" going forward.
Silvergate will hear from regulators if it hasn't already. Last week, the Federal Reserve, FDIC, and Office of the Comptroller of the Currency issued a joint statement warning about risks crypto assets could pose to the broader banking system, saying, "It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system."
The statement went on to say that "issuing or holding as principal crypto-assets that are issued, stored, or transferred on an open, public, and/or decentralized network, or similar system is highly likely to be inconsistent with safe and sound banking practices."
Silvergate has worked closely with regulators throughout its existence, but recent events will likely subject the bank to increasing scrutiny. Regulators may believe that its crypto exposure is excessive and that it should diversify its deposit base to be less reliant on crypto activities. In a worst-case scenario, Silvergate could lose its banking charter if the review finds that it aided and abetted FTX's fraud against customers.
While I believe Silvergate is an integral part of the cryptocurrency infrastructure, this past month has served as a stark reminder of the risk of operating in the crypto space. Investors with a high tolerance for risk may want to take a chance on Silvergate stock, but given the uncertainty of the bank's future, most people are best off avoiding the crypto bank for the time being.
