The failure of Silvergate Capital, Signature Bank, and Silicon Valley Bank has laid bare the vulnerabilities within the US crypto banking sector. This has raised concerns about the future of the industry and its potential for domestic growth, especially if the crucial infrastructure is not rebuilt. In recent months, both banks and regulators have displayed a diminished risk appetite for further crypto expansion within the broader US financial system.
Crypto Banking: A Breakthrough Originating from the 2008 Banking Crisis
The emergence of crypto can be traced back to the 2008 banking crisis, which led to a shift in regulatory focus from smaller banks to the too-big-to-fail institutions like Lehman Brothers. In January 2009, the first block of bitcoin was traded, marking the beginning of the crypto era. As awareness of crypto grew, trading expanded, prices soared, and a new ecosystem of exchanges and funded ventures took shape. Flush with billions in cash, these crypto-focused ventures sought secure avenues to store their funds.
In 2014, Silvergate stepped in to address this need and became the first US crypto bank. Initially, it experienced remarkable growth in deposits and stock value. By 2021, Silvergate had transformed from a modest community bank in La Jolla, California, with just over $1 billion in deposits to a $14 billion crypto-friendly financial institution. During this period, the San Francisco Federal Reserve, its primary regulator, seemed unconcerned about Silvergate’s rapid expansion and concentrated industry risk strategy. Other banks also entered the crypto arena, eager to capitalize on its potential. In 2018, Signature Bank, based in New York, rapidly grew its digital assets deposits to account for 20% of its funding base, equivalent to $20 billion. By 2022, Signature Bank had become the largest crypto bank in the country. Silicon Valley Bank, to a lesser extent, also ventured into crypto banking, providing services to Circle, the world’s second-largest stablecoin producer based in Boston. This single customer alone parked over $3 billion of uninsured funds with the bank. Silicon Valley Bank was also the first to bank Coinbase, the largest US-based exchange.
In addition to deposit, lending, and money transfer services, these banks brought legitimacy to an industry that had been known for weak internal controls, inadequate board oversight, and lax anti-money laundering measures. With this newly established banking infrastructure, the crypto industry appeared poised for sustained and rapid growth.
The Collapse and the Domino Effect
The collapse of the scandal-ridden FTX in November 2022 triggered a chain reaction that exposed the weak safety and soundness practices of the crypto banks. FTX had nearly $1 billion deposited with Silvergate, representing approximately 9% of the bank’s total funding. When FTX failed, it swiftly withdrew all its funds from Silvergate and Signature Bank. This instilled greater nervousness among remaining depositors, and by the fourth quarter of 2022, these banks faced significant depositor runs. As a result, Silvergate failed on March 8, SVB on March 10, and Signature on March 12. In just four days, the central US crypto banking sector collapsed. While other banks like Cross River Bank in New Jersey continue to offer crypto services, their scope and reach pale in comparison to the three failed financial institutions.
These sudden failures and depositor runs extended beyond crypto banks, affecting non-crypto banks such as Credit Suisse and First Republic Bank. This further heightened regulators’ concerns about the potential spillover effect that crypto could have on the larger banking sector.
The Importance of Addressing the Systemic Risk
It would be naive to assume that the bank run triggered by Silvergate could have been mitigated if the crypto risk had been spread among more banks. On the contrary, if more banks had employed similar weak banking practices, it would have only amplified the systemic risk.
Even before the failures in March, regulators were already cooling towards crypto banking. In January, the Federal Reserve issued a joint regulatory warning, highlighting the risks associated with banks targeting digital asset customers. The Securities and Exchange Commission (SEC) has also taken an increasingly anti–crypto stance, intensifying legal actions against Binance and Coinbase, the two largest exchanges in the industry.
This cooling trend is also reflected in the level of venture capital (VC) funding for crypto. In the first half of 2023, VC funding has plummeted by over 90% and shows no signs of immediate recovery.
Breaking the Chokehold: Remedies for Sustainable Growth
The series of crypto scandals, recent bank events, and tighter regulatory scrutiny have created a chokehold that, if left unresolved, will hinder the industry’s growth, limit innovation, and compel businesses to relocate to more crypto-friendly jurisdictions like Switzerland, Singapore, and Puerto Rico.
FinTech innovation, including blockchain technology, holds immense promise for providing secure and decentralized methods of transferring and storing value. However, for the crypto industry to thrive, it requires the support of reliable banks and adequate funding. It is crucial for the industry to establish better internal self-regulation and adopt higher standards of conduct. Banks entering the crypto space must also adhere to stronger risk management practices. By applying proper banking protocols to crypto, the chokehold on the industry can be alleviated. Regaining regulatory trust will pave the way for the thawing of the current freeze and open doors to future growth.
