Does it feel like the crypto market has been acting a bit weird lately? Well, it's not just you. Last week, Silvergate, the most important bank for crypto, shut off its exchange network. This network was used by large investors, companies, and stablecoin issuers to move billions in and out of the crypto market 24/7. The absence of this ability seems to have profoundly affected crypto market liquidity, and the insolvency of Silvergate increases the risks that regulators will accelerate their crackdown on crypto. So, today, I'm going to tell you everything you need to know about Silvergate, including where the bank came from, how it ended up in this position, and what its collapse could mean for crypto.
With a bit of background, Silvergate is a Californian bank that was founded way back in 1988. For its first 30 years, Silvergate was a small bank with only a few hundred million dollars of deposits. Thanks to the foresight of its early executives, Silvergate was unaffected by the 2008 financial crisis. That same year, Alan Lane became the CEO of Silvergate. Now, Alan has over 40 years of experience working in the corporate banking sector, holding various executive positions.
The story goes that Alan turned Silvergate's focus to crypto after investing in Bitcoin in 2013, but the actual story is a lot crazier. In a 2019 interview, Alan said he met someone from a company called SecondMarket at a conference, which had been disrupted by Occupy Wall Street in 2011. SecondMarket's business was providing liquidity for illiquid stocks, and they were exploring providing liquidity to small banks like Silvergate. Here's where things get crazy.
The founder and CEO of SecondMarket was Barry Silbert. Barry happens to be the founder and CEO of Digital Currency Group, the largest company in cryptocurrency. Alan explained that SecondMarket reached out to Silvergate in 2013, looking for crypto banking services. For context, crypto companies have historically had a hard time getting banked. If you read my article about Operation Choke Point 2, you'll know that the original Operation Choke Point took place between 2013 and 2017. It's believed this is why crypto initially struggled with banking. In any case, when SecondMarket first approached Silvergate, Alan was skeptical. After a few months, though, he became fascinated with Bitcoin and quickly realized that the crypto industry was an untapped market.
By 2017, Silvergate had onboarded over 250 crypto companies, and its deposits had grown to $2 billion. That same year, Silvergate came up with the brilliant idea of developing its own exchange network that would make it possible to transact fiat currencies and cryptocurrencies 24/7. This was needed because the crypto market trades 24/7, whereas the banking sector only works 9-5, Monday to Friday.
The Silvergate Exchange Network (SEN) launched in early 2018 and attracted an additional 250 crypto companies to the bank. Many of Silvergate's crypto clients became nodes on the SEN network, making it possible for them to instantly transfer cash and crypto, ensuring robust market liquidity.
Now, this is more significant than you think because Silvergate provided banking services and network access to the largest companies in cryptocurrency. These include exchanges like Coinbase, Kraken, and Gemini, and stablecoin issuers like Circle, Paxos, and TrustToken. In 2019, Silvergate held its initial public offering, meaning shares of the bank began trading on stock exchanges in the United States. Despite the crypto bear market, Silvergate's exponential growth continued, and by 2020, it had almost 1,000 clients, with hundreds more waiting to be onboarded. Earlier in 2020, CoinDesk had provided a breakdown of Silvergate's client base: "the bank now has 850 digital currency customers, including 61 exchanges, 541 institutional investors, and 248 other customers." The largest customer segment increase was in institutional investors, which increased by 32. FYI, the money from these institutional investors is most of crypto's market cap and trading volume.
In 2021, Silvergate's stock price went parabolic along with the crypto market, hitting a high of just over $217 and almost 16x increase from its IPO price. Silvergate's deposits went parabolic too, peaking at over $14 billion. The SEN Network hit almost one trillion dollars in transfers for the year. And then came 2022.
Now, Silvergate seemed fine at the start of 2022. The company had just announced its $200 million acquisition of DM, Facebook's failed digital currency project. Silvergate wanted to create a stablecoin of its own, which would circulate on its SEN Network and be used for payments. Remember this for later.
Now, when the crypto market started crashing in early 2022, Alan started getting questions from all sides about the bank's solvency. This is because Silvergate offered USD loans backed by BTC and had famously lent MicroStrategy over $200 million using BTC as collateral. Obviously, this is quite risky. Alan had a simple answer to all the skeptics, and that's that when the crypto market started to crash, the SEN made it possible to immediately sell any BTC being used as collateral. Not only that, but Silvergate was robust compared to regular banks. That's because it only held cash along with its clients' crypto and their cash. There was just one problem, well, more like two problems: FTX and Alameda Research.
The latter had opened an account at Silvergate in 2018 and had apparently passed the crypto bank's extensive due diligence checks. Now, it's believed that FTX used Alameda's account at Silvergate to move customer money around, and it appears that Silvergate may have been aware that something bad was about to happen with FTX and Alameda shortly before the pair imploded. This is because Silvergate introduced 24/7 customer support to its clients just a few weeks before and introduced a new Chief Risk Officer just a few days before. Now, to be fair, this could just be a coincidence. Shortly before FTX and Alameda collapsed, Silvergate issued a statement reassuring its clients that its SEN Network continued to work without issues, and in this statement, Alan specified that the bank had the ability to borrow from the Federal Home Loan Bank in the event of any liquidity issues.
On the same day that FTX and Alameda collapsed, Silvergate issued another statement which seemed to confirm that FDX itself had accounts at the bank. The silver lining, pun intended, was that FTX deposits accounted for less than 10 percent of all deposits. However, there was no mention of Alameda. Although Silvergate's stock rallied on the lack of FTX exposure, the recovery was short-lived. In December, U.S politicians started calling for an investigation into Silvergate over its connections to FTX and Alameda. A class-action lawsuit was also launched against the bank by some of its customers. In January, Silvergate revealed that it had experienced an $8.1 billion bank run which wiped out all of the profits it had made since 2013. Silvergate also had to cut 40 of its staff to stay afloat. It was later revealed that it had taken a loan from the Federal Home Loan Bank, bad optics. Oddly enough, BlackRock used this opportunity to buy the dip. The world's largest asset manager took a 7.2 percent stake in Silvergate, and another asset manager called State Street took a 9.2 percent stake. I should note that both allocations occurred in December 2022 but were revealed in early 2023. Unfortunately, the thud continued in February. The Department of Justice announced it was investigating Silvergate over the FTX/Alameda situation. Silvergate subsequently became the most shorted stock out there, it's the second most shorted stock at the time of shooting. Don't ask how it's doing, it ain't pretty.
Earlier this month, Silvergate announced it would be delaying its annual report, acknowledging that it could be facing many more investigations and admitted that it may not survive. Last week, Silvergate shut down the SEN network as its highest-profile crypto clients all abandoned ship to other crypto banks. The latest news is that Silvergate is winding down operations and will liquidate its assets. It's possible that Silvergate's assets will likely be acquired by a mega-bank like JP Morgan. This could potentially give control of crypto's most valuable piece of financial infrastructure to Wall Street.
So now that Silvergate has gone down, what happens next? Well, I'll start by saying that Silvergate was finished the moment it shut off the SEN. The SEN was clearly a critical piece of infrastructure for the crypto industry, so much so that Silvergate's top clients didn't bail until it was gone. As I mentioned a few moments ago, most of Silvergate's top clients have abandoned ship to other crypto banks. Now, in theory, this sounds like a solution, but in practice, it creates two more problems. For starters, Silvergate was the only crypto bank with a 24/7 network for fiat and crypto, which is sorely needed. Moreover, there are only two other big crypto banks in the United States: Signature Bank and the Metropolitan Bank. That was until January this year when the Metropolitan Bank announced it would be exiting the crypto industry due to regulatory pressure coming from the entities behind Operation Choke Point 2. This leaves Signature as the only viable option for most crypto companies, hence why most of Silvergate's top clients recently switched to Signature. The problem there is that Signature had announced back in December that it was looking to cut its exposure to the crypto industry in half. What's scary is that Signature has since started limiting banking services to some of the largest crypto companies. Some of you may recall that Signature limited USD transactions to Binance US in January. Well, they recently did the same thing to Kraken, which is truly unprecedented given its reputation. If that wasn't bad enough, Signature reportedly received $10 billion from The federal Home Loan Bank in Q4 of last year received almost triple the amount that the federal bank had learned to Silvergate. As I mentioned earlier, this is extremely bad optics and will likely lead to scrutiny of Signature. While Signature doesn't seem to have any problematic crypto clients, if Silvergate officially collapses, anti-crypto regulators and politicians will have the pretext they need to crack down on Signature and any other remaining crypto banks. They'll be able to say that crypto threatens the banking sector. This concerning state of affairs is why I strongly suggest checking which banks your favorite crypto exchange has access to. Better yet, consider withdrawing your cash to your own account and keeping your crypto in your own personal wallet. You can get a discount using the deals page in the description if you don't have a crypto wallet now. Even if the few remaining crypto banks are somehow allowed to operate without scrutiny, it still doesn't change the fact that the SEND network is offline. I'll reiterate that a network like the SEND is necessary for the crypto market to function properly. Without it, it's very hard to get money in and out. More importantly, it effectively restricts money flows to banking hours. This is a recipe for disaster when you're dealing with a crypto market that trades 24/7. We could see some serious volatility as a result or a total absence of volatility like we saw over the weekend. These disconnects could be very damaging. A new SEND network is desperately needed, but so far, it looks like only one crypto company has been brave enough to step up to the plate. A few days ago, the CEO of BCB Group, a crypto payments provider based in the UK, announced that the company is working on a replacement for the SEND. BCB Group is hoping to have its SEND alternative up and running in the second quarter of this year, potentially months from now. Until this new network is released, the crypto market will continue its strange price action. With some luck, whoever acquires Silvergate's assets will restart the SEND sooner. Now, to wrap things up, I want to talk about an aspect of the Silvergate situation that seems to have been overlooked. Nobody seems to be asking the question of why the anti-crypto regulators and politicians specifically targeted Silvergate. After all, FTX and Alameda had accounts at multiple crypto banks in the USA.
FTX and Alameda had accounts at a small rural bank called Farmington, which both companies had invested in. Farmington quietly exited the crypto industry in January and has received absolutely no scrutiny whatsoever. That might have something to do with Farmington's connections to Jeffrey Epstein. Regardless, the fact of the matter is that the excessive scrutiny of Silvergate makes very little sense on the surface. Heck, Silvergate was working with the largest institutions on Wall Street to develop a crypto exchange. This is presumably why BlackRock and State Street basically tried to help bail Silvergate out.
So, a question for you: what really made Silvergate different from all the other crypto banks out there? By now, you should know the answer. It's Silvergate's SEN network, the ability for the bank to transfer fiat and crypto 24/7, 365 days a year.
This brings me back to the topic of Silvergate's stablecoin. Remember that Silvergate was getting ready to launch its own stablecoin, which would run on SEN. In interviews across 2022, Alan explained that Silvergate's stablecoin ambitions came from watching stablecoin issuers operate for years and facilitating the issuance and redemption of their tokens. Allen noticed that the primary use case for stablecoins was cryptocurrency trading. He also realized that regulators weren't comfortable seeing stablecoins issued on smart contract blockchains being used for anything else. Quite simply, payments on a public network of any kind were out of the question.
Alan eventually realized that SEN was the ideal private network to issue a stablecoin that can be used for payments. It would be ideal because it would be capable of providing instant settlement 24/7. Silvergate's stablecoin was supposed to launch late last year but never did. What's interesting is that FTX was planning on rolling out a stablecoin of its own around the same time. Both Sam and Alan had said that they were working with companies in the crypto industry to launch their respective stablecoins. It's possible that they were working together on these stablecoin ambitions.
I speculated that they were ultimately taken down because they wanted to create a stablecoin that would compete with the incumbents, namely Circle's USDC. However, I'm starting to suspect that Silvergate was the real target. Take a second to consider that Alameda was once one of the largest market makers in cryptocurrency. Because of their position, they had close connections to all the largest companies in the industry. This included the largest exchanges, stablecoin issuers, and of course, almost all the crypto banks.
As for Sam, he had close connections to the very same anti-crypto regulators and politicians who are coordinating Operation Choke Point 2. He met with Gary Gensler more than any other regulator. Sam also likely has lots of sensitive information about the crypto industry, thanks to Alameda and FTX. This peculiar state of affairs is why I suspect Alameda's true purpose was to collect sensitive information about the crypto industry, precisely to orchestrate the current crackdown. In this case, I suspect Sam may have shared info about Silvergate's stablecoin with U.S. authorities after working with Silvergate on FTX's.
I suspect that when they saw that Silvergate Stablecoin was built for payments and provided 24/7 settlement, they realized that this looked identical to the Federal Reserve's upcoming FedNow fast payment system. Then they realized that they needed to get rid of Silvergate and the SEN ASAP. Put simply, Silvergate's upcoming stablecoin may have been seen as a competitor to the Fed's own upcoming payment system. Unlike private stablecoins from commercial banks and regular stablecoins, Silvergate Stablecoin would see rapid retail adoption because of the SEN and its Wall Street backing. The Fed saw this and said, "Hell no!" They do not want Wall Street involved in issuing a de facto digital dollar, and they certainly don't want crypto to be a part of it either. The U.S. government wants to maintain total control of its currency, and that is fundamentally why it's fighting the crypto industry right now. Okay, I know that this is all a great deal of speculation, but it makes enough sense that it's impossible to ignore. That said, of course, I don't always get it right, and I would love to get your thoughts in the comments section.
