Banks go where the money is. So when a market overextends and subsequently collapses, it’s no surprise they’re sometimes left holding the bag.
Crypto is no exception. While major banks stayed away from what Jamie Dimon called a “decentralized Ponzi scheme,” many small lenders saw a profitable niche in helping to service companies operating in the fledgling 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 goes back to the digital currency’s early days — when the market was largely limited to Bitcoin. Chief Executive Officer Alan Lane was an early believer and wanted to build products to cater to the market. “What I saw,” he says, “was an opportunity to bank these companies that were essentially being de-risked from other banks.”
Identifying a disconnect between the 24/7 trading cycle of crypto and traditional banking’s 9-to-5 five-day-a-week clock, Lane set up a payment network to offer an interface between the world of dollars and the world of crypto. His Silvergate Exchange Network (SEN) allows users to move dollars between each other so that they can settle the fiat side of their crypto transactions any time of the day or night. The network was used by many of the major players in crypto and passed $1 trillion in cumulative payment volumes earlier this year. One customer was FTX, whose now-disgraced founder, Sam Bankman-Fried, was a fan.
“Life as a crypto firm can be divided up into before Silvergate and after Silvergate,” he said. “It’s hard to overstate how much it revolutionized banking for blockchain companies.”
Silvergate profited from deposits that digital asset customers left on its network. At the end of September, those deposits were 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% over the three months to September.
The problem now is not only that FTX has gone away, but other customers are going away too. Silvergate has disclosed that FTX represented less than 10% of deposits from digital asset customers; then, it revealed that average deposits quarter-to-date were down 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 wires, effective immediately and until further notice.” (FalconX said Monday it would resume using the service.)
To honor withdrawals, Silvergate will have to tap its securities portfolio to raise cash. But rising rates have impaired the value of that portfolio – the bank was already sitting on $1 billion of unrealized losses at the end of September. In addition, a chunk of the portfolio ($3.1 billion) is in a held-to-maturity sleeve, which accounting standards prohibit it from touching. Silvergate’s market value, which rocketed to above $4 billion at its 2021 peak from about $200 million in early 2020, is back down below $1 billion.
Provident has a different kind of exposure to crypto. Founded in 1828, it’s one of the oldest banks in the US, 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 highly capitalized as new shares were issued in the conversion process. Looking for ways to invest its excess capital, the bank stumbled into crypto. It first launched deposit and cash management services for digital-currency customers and, in late 2020, it rolled out lending as well. “Old banking is boring,” the company notes in its investor materials.
Provident made loans supporting crypto-backed lending, margin trading and crypto-mining operations. By mid-2022, it had built its crypto-related loan book up to $139 million, equivalent to 58% of its equity capital. But the collapse in digital-asset markets has made recovering some of these loans tricky. The bank has delayed its third-quarter earnings filing to review those loans, indicating that losses may amount to $27.5 million, stemming from impairments on $104 million of crypto-mining loans.
Several other small banks have exposure to crypto. New York-based Metropolitan Commercial Bank looked after $1.5 billion of deposits from digital-currency businesses at the end of 2021, equivalent to about a quarter of its total deposits. One of its major clients was Voyager Digital, whose July bankruptcy filing required Metropolitan Commercial Bank to return deposits to its end-users. By the end of September, deposits from digital businesses had halved.
For now, some banks are claiming their crypto businesses are resilient. Signature Bank, also based in New York, has been a receptacle of digital-asset related deposits since 2018, and in 2019 launched a payments network like Silvergate’s. It previously offered loans collateralized by certain types of cryptocurrencies but is no longer in that market. At the end of September, Signature Bank had $23.5 billion of digital asset deposits on its balance sheet, representing about a quarter of its overall deposits. Around $12.3 billion of the total derives from exchanges, of which FTX forms a sliver. Last week, the bank informed investors that balances were stable.
Customers Bancorp, of West Reading, Pennsylvania has also said that, for now, balances are stable. It operates a blockchain-based instant payments system using its own non-listed token, CBIT. Last week, deposit balances sat at $1.85 billion, compared with $1.9 billion at the end of September.
The banks’ compliance procedures are sure to attract greater scrutiny. Sam Bankman-Fried has indicated that transfers meant for FTX may have been directed towards its sister company, Alameda Research. The new CEO of FTX, charged with overseeing its bankruptcy, has said he’s never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”
All of which raises a new question facing banks that did business with FTX: Did you know your customer?