Crypto Crisis: Bitcoin Falls Amid Silvergate Bank Troubles

Bitcoin Falls for Fourth Straight Day Amid Silvergate Bank Troubles

The world’s largest cryptocurrency, Bitcoin, has hit a two-month low as a selloff in the digital asset market intensifies following the collapse of another industry leader. The cryptocurrency fell for the fourth consecutive day, dropping 5.7% on Thursday to trade around $20,800. Meanwhile, tokens like Ether and Dogecoin also edged lower, losing 5%.

Silvergate Capital Corp, a crypto-friendly bank, recently announced plans to wind down operations and voluntarily liquidate its bank, causing renewed turmoil in an industry already rocked by a series of blowups. The company’s unraveling coincides with heightened regulatory scrutiny of the industry, putting some investors on edge. The losses in the US equities space also amplified amid a selloff in the banking sector.

According to Kara Murphy, Chief Investment Officer at Kestra Investment Management, it’s hard to make a fundamental argument for crypto given all the uncertainty surrounding the industry, particularly regarding regulatory changes. The situation is not helped by the possibility of higher borrowing costs, particularly in the US, as central bank officials work towards reining in surging inflation, a situation that doesn’t bode well for riskier investments such as digital assets.

Despite the negative news, recent volatility has not hit crypto prices as hard as in the past. Bitcoin has gained roughly 26% since the beginning of the year, marking an impressive run, although it only recovers a fraction of the ground it lost last year when the coin shed 64%. The cryptocurrency was hit by the implosion of the Terra stablecoin, the failure of hedge fund Three Arrows, and the spectacular collapse of the FTX exchange.

Senior financial markets analyst at City Index, Fiona Cincotta, noted that Bitcoin is definitely in better shape than it was at the end of last year. “I don’t think that it’s the start of a new extended fall lower yet, but that’s not to say that it might not come,” she added.

The recent negative news has caused spot volumes to drop, and they are currently at a two-month low, down 21% in the past seven days, according to Vetle Lunde, senior analyst at K33 Research, formerly known as Arcane Research. The volatility in the past week was concentrated around one brief, sharp selloff last Friday as Silvergate’s troubles mounted, Lunde added, which “naturally disincentivizes” market activity.

The recent turmoil in the crypto industry has led to a selloff in digital assets, including Bitcoin. While some market watchers are optimistic about the situation, others are concerned about the regulatory uncertainty and the possibility of higher borrowing costs.

Silvergate Bank Role in the Bearishing Crypto Market

Silvergate Capital Corp, a bank focused on cryptocurrency, has faced significant challenges as it braces itself for a potential closure. Short sellers were attacking it, depositors withdrew their funds, and business partners distanced themselves from the bank.

Before the recent crisis, Federal Deposit Insurance Corp. Regulators came to Silvergate’s headquarters in La Jolla, California, to prevent the first US banking system casualty caused by the cryptocurrency industry’s implosion. One of the options they discussed was finding investors in the crypto industry to shore up the bank’s liquidity. However, a desperate round of calls to potential investors failed, as no firm was willing to associate with a bank mired in the industry’s upheaval.

See Also: The Future of Stablecoins? Arthur Hayes Proposes Bitcoin-Backed NakaDollar

With survival seeming increasingly implausible and no buyer in sight, Silvergate announced on Wednesday that it would be closing its doors, ending a decade-long dream that made it a central player in the cryptocurrency industry. In November 2021, the company’s stock traded above $200 a share, slumping 36% to $3.14 as of Wednesday 9:31 a.m. in New York.

As described by anonymous sources, the decision to wind down and liquidate voluntarily capped months of turmoil stemming from Silvergate’s ties to Sam Bankman-Fried’s FTX. The crypto exchange’s November collapse into bankruptcy, followed by allegations of fraud, placed a harsh spotlight on Silvergate and ignited a regulatory crackdown on the industry’s ties to banking.

Silvergate Bank faced significant losses after it was forced to sell securities to meet the demands of customers withdrawing their deposits. However, the bonds the bank sold were valued at a lower price than the bank initially paid. As a result, the bank incurred a staggering $1 billion loss on its earnings at the end of the previous year.

After posting $1 billion in losses in the fourth quarter and bleeding more capital this year, it was forced to delay its annual report, raising questions about its ability to stay in business. After focusing intently on cryptocurrency, the bank exposed itself to traditional banking risks, including a lack of diversification and maturity mismatches. Sheila Bair, who headed the FDIC during the global financial crisis, said, “Silvergate’s troubles are as much if not more about traditional banking risks as it is about its crypto exposure.”

Silvergate’s decision to sell securities to cover the withdrawal of deposits was not the most prudent move. The bank’s miscalculation highlights the importance of anticipating potential market changes and their impact on investments. It, therefore, remains to be seen how Silvergate will recover from this setback. Still, it is a cautionary tale for other financial institutions to remain vigilant and proactive in their investment strategies.

In 2013, Silvergate transformed itself from a typical community bank to one catering to the digital-asset industry, accepting deposits from institutional crypto players few other traditional financial institutions were willing to do business with. In 2018, it introduced a crypto-payments platform, enabling clients to exchange fiat currency at the same speed they traded digital assets on systems outside the bank, such as FTX.

The bank’s shift from traditional banking to a then-niche area reflected a broader trend in the financial industry. Smaller USA banks struggling to compete with larger rivals doubled down in areas traditional finance shunned, hoping it would give them a fighting chance, but with mixed success.

See Also: How to Profit From the Cryptocurrency Bear Market

The unique composition of Silvergate’s balance sheet also played a key role in its demise. The bank didn’t pay interest on deposits from crypto clients, creating a free pool of funding that it invested in government debt and similarly liquid assets. Its portfolio comprised mortgage-backed securities and bonds sold by state and local governments.

This setup proved problematic as the Federal Reserve hiked interest rates, eroding the value of a chunk of Silvergate’s securities. When the crypto industry faltered, and clients rushed to withdraw money, the bank’s non-interest-bearing deposits dropped from $12 billion at the end of September to just $3.9 billion at the end of last year.

According to Todd Baker, a senior fellow at Columbia University’s Richman Center for Business, Law, and Public Policy, Silvergate’s failure to anticipate the impact of rising interest rates on the volatility of its deposits and the depreciation of the value of its securities portfolio contributed to the bank’s losses.

Conclusion

In conclusion, Silvergate’s potential demise underscores the risks that smaller banks face when they shift their focus to niche areas and expose themselves to traditional banking risks. It also shows the immense risk involved in cryptocurrency investment. The bank’s failure to effectively diversify and manage its funds and balance sheet ultimately led to its downfall.