Headline: So, what DID happen with Silvergate Capital?

Body:  OK, I am going to ask you to step in the Wayback Machine with me here, and set the destination for the later 1930s.    Ok, see that long, long line of people, all queued up before that substantial looking building?  This is likely NOT an architectural appreciation society.    This is a  bank run.  In short, there were some challenging economic conditions… and then contagion took over.   One neighbor went to talk to another, “You know, Shirley down the street, she barely got out all of her money.”  Then neighbors #1 and #2 spread the word further, as they both sprint to the Bank to get their savings out.   Multiply by a few thousand people, and this is the crux of a bank run.  Yes, nowadays, the FDIC will serve to manage this, somewhat, but please note the word “manage.”   Largely, this means that the contagion will not spread to many other banks.  For the ones directly affected, FDIC can only do so much.

So, why am I telling you about bank runs that were happening about 100 years ago?  Well, they provide a decent intuitive model for what happened to Silvergate Bank.  Only, this time, Silvergate was not just a bank.   And then again, cryptocurrency was involved.  (I will tackle Silicon Valley Bank in a future article.  That one’s kind of interesting too.)  So, let’s get started.

OK, who’s on first?

As happens so often, the media has generally gotten some things wrong or, at least incomplete and somewhat confusing.   The entity that went into “voluntary liquidation” was Silvergate Bank.   In turn, Silvergate Bank is owned by a holding company, Silvergate Capital Corporation.

What happened?

Things were good, at first. In 2013, Silvergate Bank began to help the first companies within the cryptocurrency industry.   In November 2018, it filed to go through an IPO, and they revealed that they had just under 500 cryptocurrency clients.   By the time the IPO was accepted, they had over 750 cryptocurrency clients.

Just a cursory view of the news would suggest that there are multiple headwinds buffeting the cryptocurrency industry.  In response to these confitions, Silvergate Bank took a $4.3 Billion loan from The Federal Home Loan Bank in San Francisco.   These loans themselves, did not seem to unduly concern the FDIC.

Just a few weeks ago Silvergate Corporation announced that its annual financials would be delayed due to questions from its independent auditors.   (Score one for the good guys?)  Just after this, Silvergate announced that they would be hiring a law firm and a different accounting firm to help guide them through its transition.   According to Silvergate management, all depositors would receive full and complete refunds of their deposits.  (I have to wonder how they’re going to do this, given the FDIC limit of $250,000 per customer account.) ,

Within this announcement, Silvergate admitted to concerns that Silvergate Bank might have “going concern” issues.   No, this is not something that should llead to a conversation with a friendly urologist.   “Going concern” is a term of art within accounting, and when you see that phrase on an Audit Report, it means that there are things going on that concern them so much, that they believe that the company being audited will not be surviving the next 12-month period of time.   Silvergate said that they would be “voluntarily liquidating’ its assets in response to “recent industry and regulatory developments.” One of the major industry developments is the bankruptcy of FTX and its conjoined corporate twin, Alameda Research.  Silvergate (SI) sold securities and derivatives at a loss of $718 million as customers withdrew about $8.1 billion of digital deposits during the fourth quarter. This amount is far in excess of the bank’s profits since 2013, the Journal reported.

Shares of Silvergate Capital Corp., a crypto-focused California bank, lost almost half their value after the Wall Street Journal reported it spent the equivalent of a decade’s profit and fired 40% of its workers after investors scrambled to redeem $8.1 billion in the wake of crypto exchange FTX’s collapse.  Now, the FDIC has forced them to stop operations and help make good on as many of the customer demands as they can.

Is this different from what happened at other cryptocurrency-adjacent companies?

This is a very good question.  At the beginning (of the end) FTX tried to say that the problem was a “bank run” when actually, the crux of the issue was fraud being perpetrated upon unsuspecting clients.    Silvergate appears to be more of a bank run, one caused by and made worse by external factors.

Why was Silvergate at such enhanced risk?

Mainly because they held a substantial amount of their assets in cryptocurrency.  But, have faith; things can get MUCH worse, even at a traditional bank.   One main issue is how banks report bonds that they hold.   Most bonds are traded actively and are considered to be “trading  investments.   The value of these must be tested, regularly to see if their value had declined in value within the market.    If so , they have to be “written down”  to reflect market values.  But, if a bank reports them as “Held to Maturity” investments, this “mark to market” protocol does not have to be used.   The outfall of this is that the bonds held by the bank can be massively over-valued, and the bank itself can now be described as “under-capitalized.”  Silvergate was involved in a lot of this investment activity, so when the bank run began, they had very little liquidity cushion to use to satisfy customer demanded withdrawals.

What’s the outfall likely to be?

I think the predicament of the marijuana growers and retailers is comparable.   Even though these products are legal under state law, no traditional banks will touch them.  I think that a similar situation faces crypto firms.  What they do is legal, but getting financing from “TradFi” (traditional Finance, I had to look it up too) is becoming more and more complicated.  This will likely lead to a very few cryptocurrency financing companies with a lot of power.   (Think OCP for cryptocurrency.)

The Verdict

According to industry expert a Mr. Bianco, “I still think crypto is going to win the day at the end of all of this.”  I have opined on this before, and in short, I agree with him.  Within the marketplace, there are many evolving metaverses which each have their own native currencies.    But, the “on-ramp” to playing in these metaverses appears to be purchasing cryptocurrencies to trade for the native currency.   Because of the draw of these metaverses (which are getting more and more immersive each day,) I believe that cryptocurrency in some form is here to stay.  So, if cryptocurrencies are here to stay, what happened to Silvergate?   I think it comes down to a human failing.  Greed.

Time after time (especially FTX), hedge funds have worked to get people into cryptocurrency, and other firms provide marketplaces where these cryptocurrencies can be traded.   The kiss of death appears, once again, when the hedge fund works through the same corporate structure as the cryptocurrency exchange.   In the case of FTX, they began making loans to Alameda, and trading their requests on a prioritized schedule. Silvergate started providing services to the industry in 2013, with no apparent problems.  Then they instituted their own “internal settlement tool” the Silvergate Exchange Network, and now, they are defunct.   Same rhythm, same chord structure.  Not a melody I like to hear.






Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

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