[Feature] The Cause and Effect of the Silvergate Incident: Success and Failure in the Crypto Industry

Compiled by: Coinlive

Author: hellobtc — Terry

On March 1st, Silvergate Capital, a cryptocurrency-friendly banking group, announced that it would delay submitting its annual 10-K report (a document required by the U.S. Securities and Exchange Commission that provides a comprehensive overview of a company's business and financial condition) and stated that it would need an additional two weeks to complete its 2022 fiscal year report.

The news caused its stock price to drop more than 30% after hours. In addition, partners began cutting ties with its business.

Within 24 hours of announcing the delay in submitting the 10-K document, Coinbase, Circle, Bitstamp, Galaxy Digital, and Paxos all announced that they would be reducing their cooperation with cryptocurrency banks. Gemini also announced that it had stopped accepting customer deposits and processing withdrawals through Silvergate ACH and wire transfers. Others include Crypto.com, Blockchain.com, Wintermute, GSR, and Cboe Digital, among others.

As of 10:00 AM on March 3rd, Silvergate's stock price has fallen sharply by 58.7% to $5.57. The stock has fallen more than 97% since its all-time high (ATH) of $239.36 on November 30th, 2021.

In fact, potential financial problems for Silvergate began to emerge in the fourth quarter of 2022 when the company reported a net loss of $1 billion due to the November crash of FTX. This is in stark contrast to the company's net income of $75.5 million in 2021.

From this perspective, Silvergate's loss in the fourth quarter of last year was not only huge but also completely unexpected. As a regular in the world of cryptocurrency news, what kind of role does Silvergate play, what happened in the fourth quarter of 2022, and whether it can safely pass through this event will all have an impact on the cryptocurrency industry going forward.

Cryptocurrency-friendly bank Silvergate.
To sum up Silvergate in one sentence, it is a bank group that is friendly towards cryptocurrency assets, and is one of the few traditional banking institutions that deeply engages in cryptocurrency businesses and provides corresponding services.

Originally a community retail bank located in California, Silvergate shifted its business model from traditional banking services to cryptocurrency-related services starting from 2013.

In 2017, Silvergate created the Silvergate Exchange Network (SEN), which is a payment network for traders in the digital asset space. It also provides a platform for developers to create new products and services, and provides bank settlement services for companies such as Coinbase, Gemini, Bitstamp, FTX, and Alameda Research.

By transitioning into a cryptocurrency-friendly bank, Silvergate achieved a qualitative transformation and was listed on the New York Stock Exchange in late 2019.

In the cryptocurrency asset industry's boom of 2020 and 2021, many cryptocurrency and traditional institutions played extremely active roles, and Silvergate also benefited maximally: it earned $11.1 million in revenue in 2020 and $75.5 million in 2021.

Choosing to engage in cryptocurrency businesses and deeply cultivating them was the key to Silvergate's early achievement in achieving a significant scale in the industry's boom.

You can see clues from the trend of Silvergate's stock price (SI). After listing in 2019, SI was relatively stable. With the gradual rise of the market in the second half of 2020, the SI stock price began to rise. In 2021, it accelerated all the way and broke through $200 when cryptocurrency prices were at their highest, with a market value once exceeding $7 billion.

But as the saying goes, "what goes up must come down." With the industry gradually entering a downturn in 2022, especially with the continuous series of high-profile failures, SI's stock price has been declining all the way. It has fallen by more than 90% from its relative high point, with a market value of only $400 million, and its drop was over 70% after the FTX collapse.

The Silvergate crisis in the aftermath of FTX's collapse
The reason for this is that in the cyclical track of the cryptocurrency industry, being involved in business with cryptocurrency giants such as FTX is a double-edged sword. Therefore, during the FTX crisis, the Silvergate crisis gradually deepened and ultimately fell into a predicament.

After FTX's $8 billion withdrawal wave

After the FTX collapse in November, Silvergate processed $8.1 billion in withdrawal requests in just two months. Its cryptocurrency-related deposits fell 68% in the fourth quarter of 2022. To meet withdrawal demands, Silvergate liquidated its debt and suffered significant discount losses.

Recently, Silvergate even admitted that it received a $4.3 billion prepayment from the Federal Home Loan Bank of San Francisco (FHLB) at the end of last year to avoid further deposit runs. Currently, Silvergate holds approximately $4.6 billion in cash, with most of it coming from the prepayment from FHLB.

Marathon Mining's debt repayment ends

At the same time, not only is Silvergate's deposit and cash business on the line after the FTX collapse, but its cryptocurrency institutional service business is also shrinking.

In December, Bitcoin mining company Marathon repaid a $30 million Bitcoin revolving loan owed to Silvergate and released 3,615 BTC pledged as collateral.

Marathon issued a statement:

Microstrategy's $205 million loan concerns

In addition, Microstrategy obtained a $205 million secured term loan from Silvergate on March 23, 2022, which will mature in March 2025. The loan has a floating interest rate equal to the average of the secured overnight financing rate (SOFR) reported by the New York Fed for a 30-day period, plus 3.70%, with a minimum rate of 3.75%.

The loan is secured by 82,000 bitcoins, which were worth 19,466 bitcoins at the time of issuance, with a loan-to-value ratio (LTV) of 25% and a maximum LTV of 50%. If the LTV exceeds 50%, Microstrategy must deposit enough BTC or repay the loan to reduce the LTV to 25% or lower.

In June 2022, with the plummeting bitcoin price, Microstrategy deposited 10,585 BTC into the collateral account to replenish its collateral.

According to calculations, if the bitcoin price falls below $13,561, the bitcoin collateral for this Silvergate loan may face liquidation, which represents a potential drop of about 60% from current secondary market prices.

The Tragedy of Crypto-Friendly Banks
Overall, on the one hand, the trust crisis caused by the FTX explosion has led to billions of dollars of user funds fleeing and run on the bank. On the other hand, its institutional crypto business, which it relied heavily on, has also rapidly shrunk and may continue to face trouble in the foreseeable future.

Under these two factors, it seems inevitable that Silvergate's recent stock price decline and cost-cutting measures will have a significant impact on the industry's institutional level. The key reason for this is that it is one of the few banks that provide crypto services.

In short, for cryptocurrency exchanges such as FTX and mining companies like Marathon, crypto-friendly banks like Silvergate play a crucial role in providing effective "fiat-crypto asset" channel services and crypto asset mortgage borrowing.

These crypto-friendly banks are the key liquidity providers in the industry, which is a result of the accumulation of years of hard work in the crypto industry.

Looking at the entire industry, except for Silvergate, cryptocurrency banks have generally been in a downturn and are facing troubles. Abra, which completed a $22.6 million bond financing in December 2022, is also undergoing layoffs and business restructuring. Brazil's largest fintech bank, Nubank, which is owned by Warren Buffett, has also seen its stock price fall by more than half in the past year.

Overall, Silvergate's event undoubtedly sounded the alarm for the industry, and the development of the crypto bank industry will be negatively affected. The far-reaching impact on the industry's compliance and diversified development trends may have only just begun.