The stock price plummets, regulatory scrutiny intensifies, and fraud allegations arise, as crypto bank Silvergate teeters on the brink of collapse

Author: Nianqing, ChainCatcher

As of February 23, according to Market Watch, over 73.52% of the shares of crypto-friendly bank Silvergate Capital (SI) have been borrowed for short selling, ranking it as the second most shorted stock in the U.S. Silvergate's current stock price is $15.77, down more than 90% from its all-time high of $222.13 set in November 2021.

Capital is collectively shorting this largest crypto bank, including the family office of billionaire George Soros.

Recently, Moody's downgraded the ratings of Silvergate Capital and its banking subsidiary Silvergate Bank, with its standalone baseline credit assessment lowered from ba3 to b2. The long-term issuer rating of Silvergate Capital was downgraded from B1 to B3, with a negative outlook.

After the collapse of FTX, Silvergate faced comprehensive losses, including losses, layoffs, and regulatory pressure.

Silvergate is embroiled in lawsuits due to allegations of assisting and enabling money laundering transactions for FTX and Alameda. Additionally, increasing evidence seems to point to Silvergate playing "some role" in the money laundering transactions of crypto institutions. Several institutions that have been investigated by the judiciary were clients of Silvergate, including Binance.

According to Reuters, bank records and company information show that Binance transferred approximately $400 million from its Silvergate Bank account to the trading company Merit Peak, managed by Zhao Changpeng, in 2021. Binance completed the transfer using BAM Trading's Silvergate account between January and March 2021. BAM Trading is the entity operating Binance US. The U.S. Securities and Exchange Commission is currently investigating the relationship between Merit Peak and Binance. Subsequently, in June 2021, Silvergate terminated its relationship with Binance for unknown reasons.

As one of the U.S. banks that freely transferred fiat currency to crypto exchanges, Silvergate has over 1,600 crypto clients, including leading institutions like Circle, Coinbase, Binance US, and Kraken, playing a significant role in the crypto market, yet most people know little about such a pivotal institution. ChainCatcher will systematically outline the turmoil Silvergate experienced after the FTX collapse and its unique growth journey in this article.

Silvergate's Origin Story: When a Small Community Lending Bank Met Bitcoin

Silvergate is a Federal Reserve member bank located in California, founded in 1988.

The two initial founders, Dennis Frank and Derek Eisele, previously worked in the real estate industry. For over twenty years before 2013, Silvergate primarily provided commercial loans and real estate loans and mortgages to local community residents, and at its peak, the small lending bank's asset size was only about $1 billion.

In 2013, Bitcoin entered its first major bull market, breaking the $1,000 mark for the first time. This small lending bank, seeking a comprehensive transformation, keenly sensed the business opportunity—crypto companies like Coinbase were being shut out by banks.

Major financial institutions refused to provide banking services to cryptocurrency exchanges due to concerns about emerging asset classes related to money laundering and illegal drugs, and began blocking customers from transferring funds to purchase cryptocurrencies. Coupled with the 24/7 operation model of blockchain, traditional banks that closed on weekends clearly could not meet the needs of the crypto market.

Shortly after deciding to enter the crypto market, in 2014, Silvergate welcomed its first crypto client: SecondMarket, which later became the well-known cryptocurrency brokerage Genesis Trading.

In the following time, Silvergate increasingly focused on the crypto market, not only selling off its commercial banking team but also streamlining its real estate department.

In 2017, Silvergate launched the Silvergate Exchange Network (SEN), allowing crypto investors to instantly transfer dollars from their bank accounts to cryptocurrency exchanges 24/7. This proprietary, nearly instant payment network provided to participants in the digital currency industry played a crucial role in Silvergate's leadership and growth strategy.

By 2019, Silvergate rapidly became the largest crypto bank in the U.S., with 1,600 of the world's top cryptocurrency miners, exchanges, and custodial platforms using it to deposit and transfer billions of dollars monthly. At the end of 2019, Silvergate went public on the New York Stock Exchange, and just 10 months later, its stock price soared to over $200 per share from $12.

On November 7, 2019, Silvergate CEO Alan Lane (second from right) rang the opening bell at the New York Stock Exchange before the IPO began trading.

Subsequently, its management began exploring higher-risk crypto services, including launching crypto lending services and attempts at stablecoins.

In August 2019, Silvergate launched crypto lending services funded by its own balance sheet; in May 2021, Silvergate became the exclusive issuer of the U.S. dollar stablecoin for Meta's stablecoin project Diem, which was aborted after being ordered to cease by U.S. regulators. However, Silvergate still had its own ideas about stablecoin issuance, and in early 2022, it spent $200 million to acquire Diem and announced plans for a full launch of stablecoins in 2022.

Before the FTX collapse, Silvergate was almost the only U.S. bank that could freely transfer fiat currency to cryptocurrency exchanges, with clients including Circle, Coinbase, Binance US, and Kraken. Almost all major crypto institutions in the U.S. had partnerships with Silvergate.

According to Intelligencer, since Silvergate first allowed crypto companies to deposit dollars into its bank insured by the Federal Deposit Insurance Corporation, $1 trillion has changed hands on its network. Silvergate's deposits peaked at $14 billion at the end of 2021, with about 90% coming from its cryptocurrency clients.

After the FTX Collapse

The collapse of FTX became a significant watershed in Silvergate's development process. At this moment, it faced a multitude of extremely troubling issues, including a sharp drop in stock price, losses, layoffs, lawsuits, and regulatory investigations.

In November 2022, the chain reaction triggered by FTX destroyed Silvergate Bank's two largest clients: approximately 10% of Silvergate's total assets belonged to FTX, and Silvergate had over $1 billion trapped in FTX; another victim of the FTX collapse, the crypto lending platform BlockFi, was also a client of Silvergate. According to bankruptcy filings, FTX and its "related entities" held about 20 different accounts at Silvergate.

Silvergate's stock price was already plummeting in a bear market, and the FTX incident further exacerbated the situation, causing its stock price to drop another 69%. "Woodstock" Cathie Wood's fund ARK Fintech Innovation ETF nearly sold off all its shares of Silvergate Capital Corp.

After the FTX collapse, Silvergate processed $8.1 billion in withdrawal requests. To meet the large volume of withdrawals, Silvergate was forced to urgently sell about $5.2 billion in debt securities and obtained a $4.3 billion loan from the Federal Home Loan Bank (FHLB). According to the fourth-quarter financial report for 2022, by the end of last year, the customer deposits it managed plummeted to $3.8 billion, far below the $11.9 billion in the third quarter, resulting in a loss of $1 billion.

This was followed by a series of cost-cutting measures. In early January, Silvergate announced it would lay off about 200 employees, accounting for 40% of its total workforce. On January 27, Silvergate suspended its preferred stock dividend payments to seek to preserve capital.

However, compared to the losses, the comprehensive investigation by regulators into Silvergate may be even more "fatal."

Due to SBF secretly transferring about $10 billion of customer funds to Alameda Research, Silvergate, as the intermediary bank, was questioned for "playing an unknown role" in assisting FTX's fraud and crime. U.S. regulators continued to pressure Silvergate for information regarding its relationship with FTX and SBF. Its responses to the investigation have been "vague and incomplete."

Besides FTX, Silvergate was also the preferred bank for dozens of other crypto companies that ultimately faced investigation, closure, fines, or bankruptcy. These include Binance US, Huobi, and others. Court documents show that Silvergate also had business dealings with recently bankrupt cryptocurrency companies Voyager, Celsius, and BlockFi.

According to the SEC's lawsuit, Silvergate also set up dozens of accounts for the convicted Australian crypto Ponzi scheme artist Stefan He Qin; additionally, Silvergate's former shareholders and clients, the crypto exchange Bittrex, faced U.S. sanctions for transferring funds to places like Iran and Syria.

Moreover, Silvergate is facing class-action lawsuits from multiple law firms, citing a lack of adequate controls and procedures to detect money laundering incidents and failure to disclose significant adverse facts regarding the company's business operations and prospects. Critics also argue that the SEN system developed by Silvergate facilitates the easy transfer of funds between different clients, making it very suitable for money laundering criminals.

The pressure from regulation and litigation has also affected the advancement of Silvergate's other businesses, such as its long-planned stablecoin project. Last month, Silvergate revealed it had written down the value of the intellectual property and technology acquired from Diem Group at the beginning of last year, with a write-down value of approximately $196 million. Compared to the $200 million paid for these assets, this revised figure represents a loss of 98%.

It is important to emphasize that the financial regulatory pressure brought about by the collapse of FTX is not directed solely at Silvergate. According to the Wall Street Journal, U.S. banks are distancing themselves from cryptocurrency companies. The U.S. SEC is currently actively cracking down on larger participants in the crypto industry, and bankers are reassessing all risk exposures in the crypto space, even completely severing ties. At the end of January, the Federal Reserve rejected the application of crypto bank Custodia to join the system.

"Too Big to Fail"?

Silvergate did not recklessly enter this industry initially. According to its CEO in an interview, when Silvergate decided to enter this industry in 2013, it seriously considered regulatory risks and fully understood KYC and anti-money laundering policies. At that time, the team had to hire twice the compliance personnel compared to banks of similar size and set rules such as "new crypto exchanges need six months to open a bank account."

Even so, regulatory uncertainty continues to lay mines for crypto companies. Coupled with the lawsuits, Silvergate has lost the "credit" essential for its survival in the short term, making it difficult to recover from the severe blow. Silvergate's crypto clients began to seek alternatives, flowing to competitors like Signature Bank.

However, Silvergate seems to be in a "too big to fail" situation.

As mentioned earlier, Silvergate received assistance from government-funded entities in critical moments. At the end of last year, it obtained $4.3 billion from the Federal Home Loan Bank (FHLB). It is reported that most of the approximately $4.6 billion in cash held by Silvergate comes from FHLB's prepayments. This is taxpayer money from San Francisco.

Additionally, major institutions in the crypto industry, such as Circle, Coinbase, and Kraken, continue to cooperate with Silvergate, which will continue to bring profits to Silvergate as the crypto market begins to recover. As one of the largest gateways from the banking system to crypto business, if Silvergate collapses, it will undoubtedly deal another heavy blow to the entire crypto market.

However, crypto trading is indeed a "brutal business." Silvergate rose to great heights because of it, and now finds itself on the brink of collapse. Especially in the current environment where the industry has not formed a good, healthy system, the ambiguity of crypto regulation is bound to bring ongoing growing pains to the industry.