[Feature] What Does the Sudden Collapse of Silicon Valley Bank Warn About the Crypto Industry?

Compiled By: Coinlive
Author: Lawyer

Summary of the Reasons for Silicon Valley Bank's Bankruptcy:
l Direct Cause: Mismatch of Maturity Dates, Short-term Borrowing for Long-term Investment
l Root Cause: Economic Downturn → Printing Money to Stimulate the Market → Inflation → Federal Reserve Raising Interest Rates to Curb Inflation

In the past few days, a major event with a wide-reaching impact occurred in the US capital markets: Silicon Valley Bank, which has a 40-year history and has won Forbes' "Best Bank in America" award for five consecutive years, has declared bankruptcy.

What is particularly noteworthy is that this event has not only caused a stir in the traditional financial market, but also due to Silicon Valley Bank's unique history and position, it has led to widespread panic among the financial technology and virtual asset circles that are deeply intertwined with it, almost leading stablecoin giant USDC into a death spiral.

Although the systemic crisis has been resolved with the joint efforts of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), we can still gain many insights from this event.

Today, we will discuss the details of this bankruptcy case in an easy-to-understand way and talk about the possible impacts it may have on the virtual asset industry.

1. Reasons and Chronology of SVB's Bankruptcy
l Direct Cause: Mismatch of Maturity Dates, Short-term Borrowing for Long-term Investment
l Root Cause: Economic Downturn → Printing Money to Stimulate the Market → Inflation → Federal Reserve Raising Interest Rates to Curb Inflation

(1) The legendary life of SVB
Silicon Valley Bank (SVB) is not an unknown bank that can be found on every street corner. In the autumn of 1983, two investors from Wells Fargo Bank, Bill Biggerstaff and Robert Medearis, with their sharp intuition, noticed that the vibrant Silicon Valley was attracting the world's smartest and most innovative young people with its unique advantages.

It would soon become the most cutting-edge technology hub in the United States and even the world, giving rise to a large number of top-tier technology companies, which would undoubtedly have enormous financial needs.

Therefore, the two decided to establish a bank dedicated to serving the venture capital circle and deeply cultivate the emerging technology industry, and SVB was born.

This is also the main reason why SVB has such a deep involvement with the virtual asset industry: many blockchain technology companies and virtual asset projects have benefited from SVB in the early stages and have chosen to continue to work closely with SVB after maturing.

Large virtual asset companies in the industry such as Circle, a16z, and Ripple have deposited a considerable amount of money in SVB, and there are rumors that a16z's deposits there even exceed 3 billion US dollars.

Before the "collapse," SVB had helped at least 30,000 startups worldwide to raise funds, had close business dealings with 600 venture capital firms and 120 private equity firms, and had a market share of more than 50% in the startup credit market.

As the number of clients and the market grew, SVB's business scope expanded, and the assets it managed before the bankruptcy exceeded $200 billion, ranking 43rd among all banks in the United States, and winning Forbes' "Best Bank in the United States" award for five consecutive years.

So, how did such a giant collapse within 48 hours?

（2）Fatal Mismatched Deadlines and Short-term Investment in Long-term Debt
Although the terminology may be esoteric, the concepts are not complex. Let us explain in layman's terms what is meant by "mismatched deadlines" and "short-term investment in long-term debt".

To illustrate, let's say that Lee is a conservative investor who chooses to deposit a sum of money in a three-year fixed deposit at Bank A to earn a stable expected return from bank interest.

However, Lee wants to make money, and Bank A also wants to make money. So, the only way for Bank A to earn more than the interest paid to Lee is to effectively use his deposit to generate additional returns. The excess generated will become the bank's profit.

We all understand the logic, but how can it be implemented?

One simple and effective way is to use Lee's funds to make loans. As long as the loan interest rate is higher than the deposit interest rate, the bank will naturally earn a profit. However, lending has one problem: if the current economic situation is poor and the bad debt rate is high, once the funds lent cannot be recovered, the bank will suffer losses.

Therefore, Bank A came up with another solution: use Lee's money for "long-term investment in stable products" that have long repayment periods but a higher return rate than Lee's interest (such as ten-year or twenty-year government bonds).

This will enable the bank to make money while letting the funds earn interest.

At this point, (on the asset side) Lee's deposit will expire after three years, and (on the liability side) Bank A's investment in other products with a long repayment period will expire after ten to twenty years. This situation where the asset-side deadline does not match the liability-side deadline is what we call "mismatched deadlines."

Lee's short-term (three-year) deposit at Bank A is what we call "short-term debt," and Bank A's investment of this money in products with long investment cycles is what we call "long-term investment."

Through this operation, the bank aims to create a "deposit-lending interest rate spread" and make money from other people's money.

At this point, someone may ask: Lee's deposit will expire after three years, and Bank A's investment will expire after ten to twenty years.

What if Lee withdraws his deposit when it matures? Well, it's a bank. As long as enough people deposit money every day, they can easily cover Lee's "short-term debt" with liquid funds without affecting the future return on their "long-term investment." Everyone benefits.

Let's return to the case of SVB.

A few years ago, the Federal Reserve implemented a very loose monetary policy for a long period of time to stimulate the economy, and bank deposit interest rates were extremely low. SVB took advantage of this and attracted a large amount of low-cost deposits (with a deposit interest rate of about 0.25%) from depositors with short deposit terms.

Then, SVB used this money to purchase a large amount of US Treasury bonds with a yield period of over ten years (with a yield rate of about 1.6% to 1.8%), betting that there will be no global event that will cause a major economic downturn in the future, and that the Federal Reserve will continue its loose monetary policy for a long period of time.

If they win the bet, this stable and profitable investment will generate a huge deposit-lending interest rate spread for SVB in more than ten years.

It is precisely this gambler mentality that has led to the collapse of SVB today.

(3) No winners in the pandemic
The fundamental reason for the collapse of SVB was actually the global economic downturn caused by the pandemic. Under the pressure of the pandemic, various industries were severely impacted, unemployment rates skyrocketed, and not only did the US economy shrink, but many middle and lower-class people could not even afford rent. In order to solve the people's livelihood problems, the US government had to adopt a simple but effective method of direct (money-printing) cash distribution to help those who were living hand-to-mouth. As a result, under the combined influence of the early quantitative easing policy of the US dollar, the US has created an unusually high inflation rate that reached over 9% in July 2022.

Under high inflation rates and high unemployment rates, the Federal Reserve had no choice but to start raising interest rates like crazy. In addition, as mentioned earlier, the bank primarily served start-up and mature tech companies in the US, which performed poorly under the pandemic, and the tech companies were no longer extravagant.

In order to meet their operational needs, they began withdrawing deposits from SVB, resulting in a large amount of deposit outflow and a shortage of liquidity.

At this point, the Federal Reserve's interest rate hike became the last straw that broke the camel's back: depositors urgently wanted to withdraw their money and transfer it to places with higher interest rates, but because SVB had invested a large amount of funds in long-term bonds with mismatched maturities, it was unable to cash out enough money to pay depositors.

Therefore, SVB could only sell the long-term bonds and other assets purchased before to obtain liquidity to pay depositors. However, after the Federal Reserve raised interest rates, the market interest rates were much higher than the interest rates when SVB purchased the long-term bonds, making them difficult to sell.

But if SVB didn't sell, it would not have enough money to pay depositors, so it could only keep making loss-making transactions.

The problem with selling at a loss itself is not significant, as long as the reputation is well maintained, we might make a profit in the future.

However, in this era of information explosion, news of SVB's loss-making sale of long-term investment assets immediately raised concerns about depositors' savings: if they have to sell long-term investments at a loss, then SVB must have a major problem! As a result, everyone rushed to withdraw their savings, leading to a stampede, and SVB collapsed completely.

2.Latest development: The Fed steps in to provide backup assistance
Since the incident has escalated to the point where the Federal Reserve has had to step in. It is well known that finance is a circle, and the impact of SVB's bankruptcy is not only on SVB itself and its depositors.

It will not only seriously affect numerous banks, investment companies, and technology companies, but will also greatly affect public confidence in the entire financial industry and banking system.

Other banks may face the risk of collective demands for redemption by depositors.

Fortunately, humans have learned from many financial crises and established deposit insurance systems.

The Federal Deposit Insurance Corporation (FDIC) provides up to $250,000 in insurance for each account (i.e., a maximum of $250,000 per account), and the FDIC has created an entity called "Saint Clara Deposit Insurance National Bank (DINB)" to transfer SVB's deposits into it to protect customers.

All insured depositors can withdraw their saved funds. However, what about the deposits in the numerous technology company accounts that exceed $250,000? The FDIC is simply not enough to cover all these deposits.

Perhaps in consideration of the tough talk previously made by the US government of "ensuring that Web3 happens in the United States," on March 13, the Federal Reserve issued a clear message: a backup will be provided and everything will be covered.

3.Warning to the Virtual Asset Industry
The SVB bankruptcy event has had a profound impact on the virtual asset industry, second only to the current second-largest US dollar stablecoin USDC, which was almost dragged into a death spiral with SVB (a large number of secondary stablecoins anchored to USDC were trembling).

This is mainly because Circle, the issuer of USDC, still holds a huge reserve of up to $3.3 billion in SVB, accounting for about 8% of the total reserve of USDC.

Although the Fed's bailout operation really saved USDC, we have to reflect: why is it always stablecoins that collapse in the virtual asset industry?

Is this kind of virtual currency anchored to real assets more beneficial than harmful or vice versa?

We will not make a value judgment for now, but if you are a long-term player who pays attention to the virtual asset industry at home and abroad, you must be familiar with the FTX bankruptcy event at the end of 2022.

In fact, there is no significant difference between the two bankruptcy cases of SVB and FTX, except that one occurred in the traditional financial industry and the other in the virtual asset industry. Essentially, they are both the same problem (and an old problem in the traditional financial industry): a lack of transparency.

It can be foreseen that this stubborn disease will continue to exist for a long time in the future.

Finally, we firmly oppose a view: the collapse of traditional banks proves that people should put their eggs in the basket of virtual assets.

There is no causal relationship between the two, and exaggerating the various drawbacks of the traditional financial industry to promote virtual assets is a slippery slope fallacy.

What investors should really do is to maintain a calm mind and long-term stability.