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It is fair to say that we had a pretty eventful year so far, and it’s becoming a little bit hard to keep up.
Are you also confused with all that is happening with the banks and crypto?
Well, you are not alone my friend.
At this point, I’m torn between keeping up with what is happening around the world, and my mental sanity.
However, striking a balance is important - so the goal for today is to structure and summarize some of these key events for you.
Chapter 0 - Setting up the Stage
The stage for what, you ask? To borrow the term from Nic Carter, for Crypto Operation Choke Point 2.0.
By who? the US regulators of course.
Why 2.0? It seems like the original one was coordinated back in 2018 to crack down on companies considered to be high-risk.
So similar to 2018, the US regulators are making it difficult for crypto companies and projects to get access to banking services.
The first indication of this was when JP Morgan shut down Uniswap founder’s bank account at the beginning of 2022.
What seemed like an isolated case picked up steam after the collapse of FTX and Alamed.
In January this year, the US Federal Agencies released a joint statement suggesting banks stop holding crypto and stay away from crypto customers. A few days later, Silvergate and Signature Banks were downgraded by rating agencies for their crypto connections.
This is just the beginning.
Let’s dive into the first domino to fall.
Chapter 1 - Silvergate Bank
Silvergate is a Californian bank founded in 1988.
It has always been a relatively small bank, until it open its services to crypto companies around 2013. By 2017, Silvergate has onboarded over 250 crypto companies and deposits have grown to $2B.
In this context, Silvergate developed a critical piece of infrastructure for the crypto space in 2018: the SEN (Silvergate Exchange Network). This exchange network made fiat currencies and cryptocurrencies transactions possible 24x7. This is highly relevant because crypto trades 24x7 all year round, unlike the banking sector.
Silvergate even wanted to create a stablecoin of its own to circulate on its SEN network that can be used for payments.
They provided this service to the largest names in the crypto industry, including Coinbase, Kraken, Geminy, Circle, Paxos, to name a few.
In 2019 Silvergate held its IPO. Its exponential growth continued despite the bear market.
Then came 2022.
It is believed that FTX used Alameda’s account at Silvergate to move customers’ money around, which gave the US politicians enough reason to call for an investigation into the bank.
This has caused a bank run, and by the beginning of January, Silvergate had to sell off its assets at loss and cut 40% of staff to cover $8.1B in withdrawals.
Fast forward to March, Silvergate announced the shutdown of its SEN network. It will be winding down operations and will liquidate assets.
Chapter 2 - Silicon Valley Bank.
Silicon Valley Bank, or SVB, is a 40 year old bank based in California. They made a name in the startup scene, claiming to have banked around 50% of US startups.
Their strategy was to offer attractive loans in return for the startups to use them exclusively. On top of that, they also provided personal services to startup founders.
Due to this, SBV had a lot of assets they needed to generate a return on while still investing in relatively safe assets. Somehow by the end of 2022, it had about $74B of loans and $120B of bonds.
All you need to understand is that:
This is a model that works well when deposits are flowing in, and interest rates are low. However, with the Fed continuous rate hike in response to inflation, money was no longer as available anymore.
When the interest rates are high, the value of the bonds will fall, and SVB had $120B in this asset class - this meant a huge hole in their balance sheet.
Normally if the bank can weather this storm without having to cash out these bonds, and inject liquidity, it might survive. However, managing this ticking time bomb is extremely difficult. Also, it won’t make a good story if nothing dramatic happens, right?
So yeah, even though SVB was working to raise funds to avoid insolvency, the word began to spread like wildfire, and voilà - habemus bank run.
At the time of insolvency, it was the 16th largest bank in the US, with $209B in assets.
To make matters worse, even though SVB is FDIC-insured, the insurance scheme only protects accounts that hold up to $250K USD. When it comes to startups, they normally have immense capital commitments and will of course will exceed this figure.
This means that more than 85% of SVB deposits were not really insured.
The silver lining here: US Treasury, Federal Reserve, and FDIC launched a joint statement around mid March that they will be backstopping all the deposits at SVB and the customers will have access to their funds.
However, almost at the same time, the US regulators also announce the shutdown of Signature Bank… which brings us to the next chapter.
Chapter 3 - Signature Bank
Let’s start from the beginning.
Signature Bank was founded in 2001 and was based in New York City. It catered to small and medium-size businesses, and did its risk offset by extensive due diligence of their clients, and only investing deposits in the safest assets. Its strategy was to help its client make money, which will then result in more deposits in the bank.
This worked out quite well. Signature Bank grew its deposits from $50M in 2009 to over $50B in 2019. Yeap, a whopping 10x.
During the 2008 financial crisis, Signature Bank’s founders got intrigued by Bitcoin, and realized that the crypto industry was unbanked, and the rest is history.
Just like Silvergate, Signature also provided banking services for the biggest companies in the industry. And just like Silvergate, it also developed and launched Signet, a platform that made it possible for its clients to transact 24x7.
Both banks were very similar, and of course had some overlap in their clients. The difference is that Signature only held cash on behalf of clients, whereas silvergate held both cash and crypto. Also, Silvergate allowed its clients to use crypto as collateral for loans.
Talking about similarities between both banks, Signature also started having issues after the collapse of FTX and Alameda, and announced that it will be reducing its crypto-related deposits by $10B (almost 50% of the banks crypto related deposits).
And right after Silvergate’s bankruptcy, New York regulators abruptly shut down Signature alleging “systemic risks”.
This created huge issues and impact - which brings us to the depeg of USDC.
Chapter 4 - USDC Depeg.
Circle Internet Financial, or Circle for short, is founded in 2013. In 2018 it released its stablecoin USDC on the Ethereum blockchain.
Besides its primary usecase for DeFi, USDC is also well-known for being used as a hedge against something going wrong with other stablecoins.
This is because it is fully regulated and very transparent in its 1:1 peg, as it provides a real-time breakdown of the assets in reserve backing USDC, and a monthly report providing further details, including where it keeps its cash reserves. Due to this, it is considered the safest stablecoin in crypto.
Then how did they lose their peg?
When Silvergate went under on the 8th of March, Circle moved its assets out of Signature to avoid a similar fate, and started doing the same for its other banks, including SVB. But yes, Circle was late to the party, and got caught up in the bank run: its bank transfer didn’t go through.
Now, in Circle’s Reserve report in January, it stated that it held some of its cash reserve with SVB, so when the bank went under on the 10th of March, speculations started and again, words spread.
Turns out, $3.3B was stuck there (around a third of Circle’s cash reserve, and 8% of assets backing USDC) - this caused USDC to immediately lose its peg.
Up until now, the way USDC has managed to maintain its peg to USD was the minting and burning of USDC in response to changes in demand. One of the main reasons this was possible is because it had access to networks like SEN and Signet that enabled transactions 24x7.
Let’s remind ourselves that this was no longer possible thanks to the shutdown of Silvergate, and Signature shortly after.
So to sum up, USDC depeg was triggered by SVB insolvency - and further jeopardized by the inability to do transactions due to Silvergate and Signatures shut down.
Luckily, Circle managed to secure a partnership that allowed it to process the backlog of transactions, and successfully regain its peg.
In hindsight though, this was a truly scary moment for the crypto space. Even though we all had confidence in the reserves backing USDC, you never know where the next black swan event will come from, and the impact of a collapse of something of the magnitude of USDC is really unthinkable at this point.
The good news is, this effectively demonstrated its resilience and moved USDC into a battle-tested status.
Closing Off this first part…
We’ve gone through a lot in this last quarter.
And this is not all of it - There is more, but let me close “part 1” of this series here to avoid a lengthy, overwhelming article.
Now, some provoking questions/thoughts…
Why Silvergate? and more importantly, why were the regulators targeting Signature bank?
Silvergate was worse off because almost 10% of its total deposits came from FTX, which was not the case for Signature, with only 0.1% exposure.
A lot of people think this is part of the choke point operations, particularly when the FDIC sold Signature Bank’s asset to Flagstar Bank a week after its shutdown - crypto assets not included.
Again, why Silvergate and Signature?
Remember all the similarities both Banks had in terms of their key infrastructure: SEC and Signet. Is it a coincidence that both offered the exact same value add as the upcoming network the US Fed is developing? Yes, the Fed is aiming to launch FedNow in July this year.
So something to think about.
…………………………………
Lastly…
In a matter of weeks, the last remaining crypto-friendly US banks were shut down, and the crypto industry has been effectively unbanked.
Yes, this might slow down the development of the crypto industry. But this will only re-emphasize why crypto matters. Additionally, crypto is geo-agnostic, so it will only drive these companies from the US to other countries.
This brings up an interesting point about how this will end up contributing to the boiling power dynamic shift globally.
Closing off part 1 - more to come about this as there is a lot more happening. If you don’t want to miss out on part 2, make sure to subscribe and stay tuned!
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