Silicon Valley Bank’s Collapse And It’s Disastrous Impact On The Crypto Industry
The crypto industry can’t quite catch a break. We’ve barely recovered from the crypto meltdowns of 2022 (FTX, Celsius, Voyager etc) when yet another incident has pulled us back into the spotlight.
The traditional banking system is typically referred to as one of the safest industries but the recent string of banking failures is proving otherwise. One banking collapse in particular may have set the crypto industry back a couple steps…
SVB Collapse (The Abridged Version)
Silicon Valley Bank (SVB) had been around for 40 years before shit hit the fan. Being the 16th largest bank in the US with $209 billion in assets did not mean that it was too big to fail but instead, that they had more to lose.
SVB had carved out a niche for itself in the startup and tech community, banking at least half of the US venture backed startups. In 2021 and early 2022, many startups were flush with cash after obtaining liquidity through IPOs, venture cap investments, acquisitions and other fundraising activities. SVB struggled to grow its loan book fast enough to keep up with the rapid rise in its deposits which led them to invest in safe securities i.e. US Treasury bonds and mortgage-backed securities.
But when the Fed started raising rates in 2022, SVB was hit with a double whammy:
- VCs found it difficult to raise funds because the risk return of investing in startups was less attractive compared to bonds, which were now higher yielding. This slowed the deposit growth for SVB.
- When interest rates rise, bond prices fall. Long-maturity bonds are more sensitive to interest rate changes because they have greater duration. SVB’s $120 billion bond portfolio of long-maturity bonds were not spared, especially because SVB made the mistake of failing to hedge their securities against interest rate risk. At the end of 2022, the mark-to-market losses for SVB were in excess of $15 billion.
Because of the fall in value of its bonds, Moody’s rating agency warned SVB of its potential downgrade. To mitigate this, SVB decided to sell $20 billion of its lower yielding bonds in exchange for assets that delivered higher returns. This resulted in SVB realizing $1.8 billion in losses but they thought they could make up for the shortfall with a share sale.
And in all fairness, this would have worked. But SVB had not done the preparatory work needed to get investors to commit to a deal of this size. The news of the planned share sale spread too quickly and spooked the market — SVB’s stock plunged 60% and VCs started to withdraw their deposits from the bank. And because bank runs are a self-fulfilling prophecy, you can probably guess what happened next…
The effect of SVB’s collapse started to ripple through markets, particularly having a disastrous impact on the crypto community.
1. “Extinction Level Event For [Crypto] Startups”
SVB banked over 50% of US startups and was a lifeline for many crypto companies. It was actually one of the few banks in the US that offered its services to the crypto community. According to Garry Tan (CEO of Y Combinator), SVB’s meltdown was like an “extinction level event” for these companies and would set startups back 10 years or more.
Many of these companies were struggling to make payroll and had to shut down or lay off workers as a result of this banking failure. Some of the crypto names that had exposure to SVB were BlockFi, Ripple, Avalanche, Yuga Labs and Proof.
The SVB collapse has also brought to light the inadequacies of the US banking system. For instance, SVB was Federal Deposit Insurance Corporation (FDIC) insured. But FDIC only protects up to $250k of deposits and since startup companies usually have immense capital commitments, it didn’t make sense for them to hold less than that amount in the bank. For some crypto startups, monthly payroll would already exceed $250k. Therefore, this meant that over 85% of the deposits at SVB were not insured.
Another hole in the system was highlighted when the Secretary of the Treasury, Janet Yellen, admitted that smaller banks that did not pose a systemic risk to the financial economy would not be fully insured. This threatens the demand for smaller banks as why would anyone want to bank with unprotected banks when they have the alternative of banking with a larger, FDIC protected bank?
2. Coming Full “Circle”
The biggest shock to the crypto industry came when everyone realized that USD Coin (USDC) issuer Circle was also affected by the meltdown. After SVB’s collapse on 10 March, USD Coin issuer Circle announced that almost $3.3 billion of the reserves backing USDC (out of $40 billion) were stuck in SVB.
Even while Circle assured holders that it was still manageable, this caused panic amongst investors. USDC is a stablecoin, and by definition it is supposed to be stable and maintain a constant value = $1. But, with USDC no longer being backed, it slipped from its peg and tumbled down to $0.87.
The depegging of USDC caused even more panic in the crypto industry as it is popular amongst both decentralized and centralized ecosystems. This caused holders to start swapping their USDC for other stablecoins available in the market. Other smaller-circulation stablecoins lost their pegs as well, including MakerDAO’s DAI and Binance’s BUSD.
The bank run at SVB also sparked fears of it spreading to other banks, because that is typically what happens in a bank run. And since Circle kept the remainder of its cash reserves at a number of other banks, investors were on edge. While USDC eventually regained its peg to the dollar shortly after that, the incident highlighted something we’ve always feared about stablecoins: counterparty risk.
The depeggings have highlighted the limited number of off-chain financial institutions, which in turn limits the stability of stablecoins. Because of this, it’s highly likely that we’ll see an increase in the regulatory scrutiny of stablecoin issuers in the US.
TL;DR
Stablecoins are vulnerable to bank runs.
3. The Unbanking Of The Crypto Sector
The collapse of the three most crypto friendly banks in the US (Silvergate, Silicon Valley Bank and Signature Bank) meant that in less than one week the crypto sector was left unbanked.
It has never been easy for crypto companies to obtain direct accounts with banks because of the perceived risk involved with crypto. Before Silvergate Bank, Signature Bank and Silicon Valley Bank opened its doors to crypto, crypto firms had been forced to obtain indirect bank accounts through intermediary firms. Now that its back to square one, some crypto firms are considering relocating their business to locations more welcoming of crypto.
Other than maintaining deposits for crypto companies, Silvergate and Signature Bank provided vital infrastructure that helped move more than $2 trillion to and from digital asset markets. The Silvergate Exchange Network (SEN) and Signature Bank’s Signet were real-time payment platforms that allowed crypto firms to exchange cash and crypto between themselves 24/7. This is important because the crypto market also trades 24/7 and networks like these provide operational efficiency for large exchanges and stablecoin issuers like Coinbase and USDC.
The closure of these banks and their respective payment networks is a major step back for the industry as it was relied on by many major crypto firms like Binance, Kraken and Gemini. Now these companies are forced to use wire transfers instead, which are costlier, slower and only available during banking hours.
Crypto Keeps Hodl’n On
As a result of SVB’s banking failure, we’ve seen startup companies experience a huge setback in operations and innovation, the depegging of USDC stablecoin and the unbanking of the crypto sector. As damaging as these incidents have been on the crypto market at large, they are only a temporary setback.
The banking collapses are still relatively new and in the meantime of waiting for other institutions to fill the gap, crypto liquidity will take a hit. However, on the bright side, this will be an opportunity for other players to step up to the challenge of providing better solutions to the crypto market.
This isn’t the end of crypto banking — institutions that fail to adapt to accommodating for crypto will simply be left behind.
