Silvergate’s worsening crypto losses are feeding watchdogs’ worst fears

by Arthur · March 2, 2023

(Bloomberg) — For months, U.S. authorities have been scrambling to cut ties between banks and risky crypto ventures, worried that the financial system could one day suffer serious losses. They may have been out too late.

Most read from Bloomberg

In the strongest warning yet from a U.S. bank that has approached the sector, Silvergate Capital Corp. on Wednesday that they need more time to assess the extent of damage to their finances stemming from last year’s crypto rout — including whether it can remain viable. The shares plunged as much as 33% after the close of regular trading.

The firm, which already reported a loss of $1 billion for the fourth quarter, said the figure could climb higher. The company is still counting the costs of quickly selling assets to repay advances from the Federal Home Loan Bank System. It may also be necessary to write down the value of some remaining holdings.

That could result in “being less than well capitalized,” La Jolla, Calif.-based Silvergate wrote in a regulatory filing. “The company is assessing the impact these subsequent events have on its ability to continue as a going concern.”

Read more: Silvergate plunges as the bank studies the status of “going concern”

Such an admission by a lender with federally insured deposits and more than $11 billion in assets will add to a debate among US lawmakers and regulators about whether banks can handle the risks associated with digital assets.

For a time, Silvergate excited its shareholders with what seemed like a novel approach: soaking up cash deposits from crypto ventures to invest in more stable securities. But when Sam Bankman-Fried’s FTX empire collapsed in November, the bank’s clients pulled back en masse to weather the storm, forcing it to offload its holdings at a loss.

“It confirms the fears that many regulators have had,” said Todd Baker, a senior fellow at Columbia University’s Richman Center for Business, Law and Public Policy. “If this bank fails, it will be held up as an example of why banks should be extremely conservative with crypto companies.”

And even if that doesn’t happen, Silvergate’s efforts will draw even more caution from regulators, he said.

Regulators’ warnings

Indeed, an American breakdown has already begun.

In early January, three top financial regulators – the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. – a stark warning to banks that uncontrollable crypto-related risks should not be allowed to infect the banking system.

Later that month, the Fed made a policy statement when it rejected a bid by crypto firm Custodia Bank Inc. to gain coveted access to the central bank’s payment system. And last month, Bloomberg reported that Binance Holdings Ltd., the world’s largest cryptocurrency exchange, was mulling whether to end relationships with U.S. partners amid the tighter regulatory regime.

Meanwhile, the Securities and Exchange Commission targeted stablecoin issuers and so-called staking, a practice of generating returns by holding tokens.

Silvergate waded deeper into the US political debate when it revealed in early January how it had stabilized its balance sheet after selling billions in assets to pay depositors. At the end of last year, the firm had $4.3 billion in short-term loans from the Federal Home Loan Bank, a program originally set up under President Herbert Hoover to strengthen mortgage lending.

The bank said Wednesday it sold more securities in January and February to pay off those advances, potentially exacerbating losses.

“All advances were at all times fully collateralized while outstanding,” Federal Home Loan Bank of San Francisco said in a statement Wednesday.

Market route

Silvergate’s shares fell more than 88% last year, first when crypto prices fell and later when FTX collapsed. Shares have been on a rollercoaster ride since — at one point swinging more than 50% in a single day — as investors struggled to gauge the company’s prospects for revival.

The stock rose in mid-January as the company outlined steps to move forward. But at the end of the month, a bipartisan group of US senators accused Silvergate of being “evasive” about the extent of its ties to FTX and Bankman-Fried’s investment arm Alameda Research. And days later, Bloomberg broke the news that the Justice Department’s fraud unit is looking into the bank’s dealings with FTX and Alameda.

On Wednesday, Silvergate listed the Justice Department’s investigation and increased regulatory scrutiny among factors that could ultimately affect financial results.

Its legacy in the crypto market, and the broader regulatory effort, could also complicate any efforts to find a buyer.

The bank’s problems, in turn, could have implications for cryptocurrencies.

The current difficulty will make other banks all the more reluctant to work with crypto businesses, resulting in a chilling effect on that industry, said Henry Elder, head of decentralized finance at digital-asset manager Wave Financial.

“They were the crypto bank,” Elder said. “You’re certainly not going to see anyone come out as a crypto bank until there’s more clarity.”

–With the assistance of Olga Kharif.