Silvergate was a Federal Reserve member bank and the leading provider of innovative financial infrastructure solutions and services for the digital asset industry. This blog aims to understand what went wrong in the journey of this goliath bank that led to its downfall.
What is Silvergate Bank
Silvergate began as a thrift and loan provider in San Diego County in the 1980s, but after the subprime crisis, it shifted its focus to residential lending. In 2014, they entered the crypto market by providing bank accounts to companies providing Bitcoin-related services, forming the SEN network. The network, available 24 hours a day, allowed seamless payment transfers between Silvergate customers.
During the crypto winter of 2018, the company expanded its customer base and hired in-house software engineers to add new features to the platform. The SEN network significantly benefited Silvergate’s clients while also serving as an anchor for their zero-cost deposit base.
However, in March 2023, Silvergate decided to wind down operations and voluntarily liquidate after it was hit with losses following the dramatic collapse of the crypto exchange FTX.
The decision to shutter the bank comes after the company evaluated its ability to operate as a concern, disclosing that it had sold additional debt securities this year at a loss and that further losses mean the bank became bankrupt.
What led to Silvergate Bank’s Downfall
Following the demise of FTX (FTT-USD), Silvergate faced a significant decrease in digital asset deposits, necessitating a balance sheet restructuring and prudent policies to withstand potential bank runs. The organization took steps to ensure liquidity and accommodate deposit inflows and outflows. Silvergate reduced its workforce by 40%, adjusted its expenses, reviewed its product offerings and customer relationships, and implemented cost-cutting measures.
The management of Silvergate believed it had prudent policies in place to ensure the safety and accessibility of its deposits. The management team stated that the balance sheet was designed to withstand a 70% deposit drawdown and that cash reserves exceeded all remaining deposits. However, this was insufficient on many levels and led to the cascading series of fires that could not be extinguished and the overall fall of this once goliath bank.
Post FTX Downfall
The collapse of FTX triggered a devastating bank run on Silvergate, with customers withdrawing a staggering $8.1 billion from the bank. This resulted in a $1 billion loss because the bank was forced to sell assets, including bonds, at a lower price than their market value on the balance sheet, incurring significant losses and impairing capital. It’s not like the bonds held were poor quality; if they could hold them until maturity, they’d be fine. However, because this occurred during a rising interest rate environment, they were forced to sell before maturity, resulting in losses.
Political and Regulatory Pressure
Post the FTX debacle, Silvergate tried to mitigate the losses and recover its reputation. It Delayed the Annual Report and started taking decisive actions in its management and policies but circumstances around them did not let the firm bounce back.
The Feds and Justice Department took an interest in Silvergate’s involvement in the FTX and Alameda transactions on the Bank’s SEN Network, and their constant poking around did not sit well in the minds of the general public and reduced the Bank’s reputation even more.
To make matters worse, the bank has come under intense political pressure, which has damaged what little credibility and trust the bank had left. The Federal Home Loan Bank of San Francisco demanded repayment of the $4.3 billion loan it provided when the issues started to rise because the pressure had become so great.
Delayed Annual Report
The bank’s delayed annual report, brought on by the need to reassess the losses sustained and its ability to continue as a going concern, was the icing on the cake. Due to this, the bank’s clients started to lose faith in it, which made them stop using its SEN network, ultimately killing it. The bank’s very existence was all but lost without its SEN network. The bank went from delaying the annual filing to liquidation in a matter of days.
Lessons Learnt from Silvergate Banks Collapse
Regulators, politicians, and the macroeconomic environment did play a part in the bank’s problems, but the management team also had a part to play. In retrospect, they might have done better to spread out their funding sources or to use their resources more sparingly and not direct everything towards the bank’s cryptocurrency business.
It can be said that the bank was overly exposed to interest rates and bonds that went down with the rising interest rates. They had clients dealing in an asset class to interest rates on the funding side. Additionally, their industry was very susceptible to the rate cycle, which left them open to changes in the market.
The regulators have yet to define a proper regulatory framework for the cryptocurrency industry, which has put banks like Silvergate in a precarious position. Most agencies appear more focused on expanding their reach into cryptocurrencies than on comprehending the nature of the asset and ethical business practices. They attempt to apply twentieth-century rules to a phenomenon of the twenty-first century, but this is only sometimes successful or appropriate.
Hence it’s not surprising that litigation is often criticizing regulators due to their inability to provide proper and clear guidelines causing great confusion and uncertainty in the market.