Contagion fears emerge at crypto bank Silvergate Capital after FTX debacle

Earlier this month, Silvergate Capital gathered its staff to celebrate its transformation into the bank of choice for the cryptocurrency market. Then, the cryptocurrency market exploded.

The collapse of cryptocurrency exchange FTX has raised questions about how close the bank was to Sam Bankman-Fried’s empire. Silvergate’s share price was cut in half this month and is now down nearly 90% over the past year.

Silvergate has released more statements and announced some results to reassure investors of its stability. He said he had capital to handle withdrawals and had no outstanding loans with FTX or Bankman-Fried. The bank revealed that its deposits were down, but the volume on its network for cryptocurrency investors had increased. He says he has no losses on bitcoin-backed loans yet. But the stock continued to plummet.

“This is a fundamental misconception about the role Silvergate plays,” Chief Executive Alan Lane told CNBC Nov. 18.

The market is asking a bigger question: What happens to a bank that has transformed itself from a small commercial lender into a brokerage of the cryptocurrency world if the cryptocurrency world collapses?

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On Nov. 18, cryptocurrency trading platform FalconX told its clients that it was no longer using Silvergate. FalconX said the elevated risk in the cryptocurrency market called for more caution and told clients its decision was “consistent with other players in the market.”

“We are now in a situation where Silvergate is considered vulnerable due to the central role it plays within the system,” said BTIG analyst Mark Palmer. Shares of Silvergate are now trading at levels implying “a very dire scenario,” he said.

Short bets against Silvergate have doubled this year. It is the second most heavily shorted regional bank, based on percentage of shares outstanding, according to data from S3 Partners. (The shorter bank has a pending merger and betting against it is part of an arbitrage strategy.)

Other banks holding assets for crypto clients, including Signature Bank and Customers Bancorp, have not been hit as hard. Signup is down 17% this month, while customers are down 4.5%. Both have a more diverse mix of businesses that are less dependent on crypto firms.

Signature said its exposure to FTX was small, while clients said they had no exposure. Both said their deposits are stable.

Silvergate is known as a gateway to cryptocurrency exchanges. It helps institutional investors move dollars in and out of cryptocurrency trading platforms through its Silvergate Exchange Network, which connects investors’ bank accounts and exchanges.

A decade ago, it was a commercial real estate lender with a handful of branches in the San Diego area. Today, around 90% of its total deposits are tied to cryptocurrency clients. It has lost branches and reduced its loan portfolio. It holds no cryptocurrencies, only dollars.

With the implosion of FTX, investors sold off the bank’s shares, concerned about flight of deposits.

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Silvergate said it only holds FTX deposits and has no other lending or investment exposure. It said it now has $9.8 billion in digital deposits, down $2.2 billion, including the removal of all FTX deposits, from the end of the third quarter.

FTX held some deposits at Silvergate in what is known as an omnibus account, meaning the assets belonged to FTX clients. It was FTX’s responsibility to maintain a ledger that tracked the activities of underlying customers, a common setup for businesses that aren’t banks themselves.

The Wall Street Journal reported that FTX used client assets to help fund its related trading operation, Alameda Research. Short sellers on Twitter and social media have been asking questions about what Silvergate might have seen or should have reported about the movements between the two.

Silvergate would not have visibility into the omnibus account to know whether FTX or its underlying customers were moving assets, people familiar with the report said. FTX has stopped withdrawals and Silvergate has told customers it cannot accept direct withdrawal requests from FTX accounts. Bank monitoring looks for transactions that fall outside a customer’s expected patterns, which could be complicated by the large overlap of FTX and Alameda.

Even if the FTX deposits were to all go away, the bank says it is structured to protect itself against huge outflows. He holds nearly all of his assets in highly liquid securities like Treasuries, which he says can be quickly sold or borrowed.

“No bank in the world can honor every deposit held on its balance sheet with cash, although Silvergate may be the closest, in our view,” wrote KBW analyst Michael Perito.

Silvergate had other plans for this month. He had gathered all of his staff in California for the first time since the pandemic, people familiar with the bank said. On Nov. 7, he announced that he had promoted Ben Reynolds, his top man in the cryptocurrency industry, to president. He also appointed a new chief risk officer.

Instead of celebrating, executives found themselves taking calls and watching rumors swirl on Twitter about a potential run on the bank, the people said. They focused on making sure the network was working properly.

Average daily volume on the network so far rose to $1.9 billion this quarter from $1.2 billion last quarter, the bank said.

“After [third-quarter] earnings, we asked the question: ‘The worst is behind them?’ “Bank of America analysts wrote in downgrading the stock. ‘We were wrong.’

Email David Benoit at David.Benoit@wsj.com

This article was published by the Wall Street Journal, part of Dow Jones

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