These banks were left with the bag in the crypto implosion


Banks go where the money is. So when a market overextends and subsequently collapses, it’s no surprise that they’re sometimes left with the bag.

Crypto is no exception. While the big banks stayed away from what Jamie Dimon called a “decentralized Ponzi scheme,” many smaller lenders saw a profitable niche helping service businesses operating in the nascent space. They include Silvergate Capital Corp., Provident Bancorp Inc., Metropolitan Commercial Bank, Signature Bank, and Customers Bancorp Inc., among others. The recent collapse of FTX puts their business in the spotlight.

Silvergate’s relationship with crypto dates back to the early days of digital currency – when the market was largely limited to Bitcoin. CEO Alan Lane was an early believer and wanted to create products to meet the market. “What I saw,” he says, “was an opportunity to bank those businesses that were basically derisking other banks.”

Identifying a disconnect between the 24/7 trading cycle of crypto and the traditional 9-to-5 five-day-a-week banking clock, Lane set up a payment network to provide an interface between the world of dollars and the world of crypto. Its Silvergate Exchange Network (SEN) allows users to move dollars between them so they can settle the fiat side of their crypto transactions any time of the day or night. The network has been used by many major crypto players and surpassed $1 trillion in cumulative payment volumes earlier this year. One client was FTX, whose now-disgraced founder Sam Bankman-Fried was a fan.

“The life of a crypto business can be divided into pre-Silvergate and post-Silvergate,” he said. “It’s hard to overstate how much this has revolutionized banking for blockchain businesses.”

Silvergate has profited from the deposits that digital asset customers have left on its network. At the end of September, these deposits accounted for 90% of the bank’s overall deposit base, amounting to $11.9 billion. The bank reinvested them in securities to earn a margin: its $11.4 billion securities portfolio generated a spread of 2.2% in the three months to September.

The problem now is not only that FTX is gone, but that other clients are going too. Silvergate revealed that FTX accounts for less than 10% of digital asset customer deposits; then, he revealed that average deposits since the start of the quarter had fallen to $9.8 billion. On Friday, crypto-trading platform FalconX sent an email to clients stating, “we will not be using Silvergate’s SEN and cables, effective immediately and until further notice.”

To honor the withdrawals, Silvergate will have to dip into its securities portfolio to raise funds. But rising rates hurt the value of that portfolio — the bank was already sitting on $1 billion in unrealized losses at the end of September. In addition, part of the portfolio ($3.1 billion) is in a held-to-maturity pocket, which accounting standards prohibit him from touching. Silvergate’s market value, which soared to over $4 billion at its 2021 peak from around $200 million at the start of 2020, has fallen back below $1 billion.

Provident has a different kind of exposure to crypto. Founded in 1828, it is one of the oldest banks in the United States, operating for much of its history as a mutual holding company, owned by its depositors. In 2019, the bank demutualized into a stock holding company, leaving it very heavily capitalized as new shares were issued as part of the conversion process. Looking for ways to invest its excess capital, the bank came across crypto. It first launched deposit and cash management services for digital currency customers and, in late 2020, it also rolled out loans. “Old banks are boring,” the company notes in its investor materials.

Provident has issued loans supporting crypto-backed lending, margin trading, and crypto-mining operations. By mid-2022, it had built its crypto-related loan portfolio up to $139 million, or 58% of its equity. But the collapse of digital asset markets has made it difficult to recover some of these loans. The bank delayed filing its third-quarter results to review those loans, saying losses could be as high as $27.5 million, stemming from write-downs on $104 million in crypto-mining loans.

Several other small banks are exposed to crypto. The New York-based Metropolitan Commercial Bank was handling $1.5 billion in digital currency business deposits at the end of 2021, equivalent to about a quarter of its total deposits. One of its main customers was Voyager Digital, whose bankruptcy filing in July forced the Metropolitan Commercial Bank to return deposits to its end users. By the end of September, digital business filings had halved.

For now, some banks say their crypto business is resilient. Signature Bank, also based in New York, has been a repository for deposits linked to digital assets since 2018 and in 2019 launched a payment network like that of Silvergate. It previously offered loans secured by certain types of cryptocurrencies, but is no longer in that market. At the end of September, Signature Bank had $23.5 billion in digital asset deposits on its balance sheet, which represents about a quarter of all of its deposits. About $12.3 billion of the total comes from exchanges, of which FTX forms a slice. Last week, the bank informed investors that the balances were stable.

Bancorp customers, of West Reading, Pa., also said that, for now, balances were stable. It operates a blockchain-based instant payment system using its own unlisted token, CBIT. Last week, deposit balances stood at $1.85 billion, down from $1.9 billion at the end of September.

Bank compliance procedures will certainly come under greater scrutiny. Sam Bankman-Fried indicated that transfers destined for FTX may have been directed to its sister company, Alameda Research. FTX’s new CEO, charged with overseeing its bankruptcy, said he had never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as what has happened.” is produced here”.

All of this raises a new question for banks that have done business with FTX: Did you know your customer?

More from Bloomberg Opinion:

• Will FTX-type unicorns be the next “Big Short”? : Chris Bryant

• The Quantum Leap of Crypto Retreat for Central Banks: Andy Mukherjee

• FTX hammers more nails into Crypto’s coffin: Lionel Laurent

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is the author of the weekly financial newsletter Net Interest.

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