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Analysis | These banks were left with the bag in crypto implosion


Banks go where the money is. So when a market gets overloaded and then collapses, it’s no surprise that sometimes they’re left with the bag.

Crypto is no exception. While big banks stayed away from what Jamie Dimon called a “decentralized Ponzi scheme,” many small lenders saw a profitable niche in helping 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 company in the spotlight.

Silvergate’s relationship with crypto dates back to the early days of digital currencies, when the market was largely confined to Bitcoin. Chief Executive Officer Alan Lane was an early believer and wanted to build products to meet the market. “What I saw,” he says, “was an opportunity to bank these companies that were essentially excluded from other banks.”

Lane identified a gap between crypto’s 24/7 trading cycle and the five-day-a-week 9-to-5 clock of traditional banking and established a payment network to provide an interface between the world of dollars and the world of crypto . Its Silvergate Exchange Network (SEN) allows users to move dollars between each other so they can settle the fiat side of their crypto transactions at any time of the day or night. The network has been used by many of the major players in crypto and passed $1 trillion in cumulative payment volumes earlier this year. One client was FTX, whose now-disgraced founder, Sam Bankman-Fried, was a fan.

“Life as a crypto business can be divided into pre-Silvergate and post-Silvergate,” he said. “It’s hard to overstate how much banking has revolutionized for blockchain companies.”

Silvergate benefited from deposits that digital asset customers left on its network. At the end of September, those deposits made up 90% of the bank’s total 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 disappeared, but also other customers. Silvergate disclosed that FTX accounted for less than 10% of digital asset customer deposits; then it revealed that average deposits fell to $9.8 billion for the quarter to date. 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.”

To honor withdrawals, Silvergate will have to tap into its securities portfolio to raise cash. But rising interest rates have eroded the value of that portfolio — the bank was already sitting at $1 billion in unrealized losses at the end of September. In addition, part of the portfolio ($3.1 billion) is in a held-to-maturity sleeve, which should not be touched by accounting standards. Silvergate’s market value, which skyrocketed from around $200 million in early 2020 to more than $4 billion at its peak in 2021, has fallen back below $1 billion.

Provident has a different kind of exposure to crypto. Founded in 1828, it is 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 an equity holding company, keeping it very highly capitalized as new shares were issued during the conversion process. Looking for ways to invest its excess capital, the bank stumbled upon crypto. It first launched deposit and cash management services for digital currency customers, and in late 2020 it also introduced loans. “Old banking is boring,” the company notes in its investor materials.

Provident provided loans to support crypto-backed lending, margin trading, and crypto mining operations. By mid-2022, it had built its crypto-related loan portfolio to $139 million, equivalent to 58% of its equity. But the collapse of 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 losses could reach $27.5 million, due to impairments on $104 million in crypto mining loans.

Several other small banks are exposed to crypto. New York-based Metropolitan Commercial Bank handled $1.5 billion in deposits from digital currency companies at the end of 2021, equivalent to about a quarter of total deposits. One of its key clients was Voyager Digital, whose bankruptcy filing in July required the Metropolitan Commercial Bank to return deposits to its end users. By the end of September, digital company deposits had halved.

For now, some banks claim their crypto business is resilient. Also based in New York, Signature Bank has been a repository of digital asset-related deposits since 2018 and launched a payment network like Silvergate’s in 2019. It previously offered loans backed by certain types of cryptocurrencies, but is no longer in that market. At the end of September, Signature Bank had $23.5 billion in digital asset deposits on its balance sheet, representing about a quarter of its total deposits. About $12.3 billion of the total comes from exchanges, of which FTX is a sliver. Last week, the bank informed investors that balances were stable.

Customers Bancorp, of West Reading, Pennsylvania, have also said balances are stable for now. It operates a blockchain-based instant payment system using its own unlisted token, CBIT. Last week, deposits were $1.85 billion, compared to $1.9 billion at the end of September.

Bank compliance procedures will certainly receive more attention. Sam Bankman-Fried has indicated that transfers intended for FTX may be directed to its sister company, Alameda Research. FTX’s new CEO, charged with overseeing the bankruptcy, has said he has never seen “such a complete failure of corporate controls and such a complete absence of reliable financial information as here.”

All this raises a new question for banks doing business with FTX: did you know your customer?

More from Bloomberg’s opinion:

• Will FTX-like unicorns become the next ‘Big Short’?: Chris Bryant

• The Major Leap Forward of Crypto Retreat for Central Banks: Andy Mukherjee

• FTX hammers more nails into Crypto’s coffin: Lionel Laurent

This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is the author of the weekly financial newsletter Net Interest.

More stories like this are available at bloomberg.com/opinion

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