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Could Silvergate Bank’s financial distress threaten the stability of the Crypto Industry?

While experts weigh in on the potential impact of Silvergate Bank’s financial distress on the crypto industry, it is important to note that Silvergate Bank and similar institutions are critical for the mainstream adoption of cryptocurrencies. They provide essential services that allow crypto firms to interact with traditional finance (TradFi). Their potential insolvency or regulatory investigations could lead to a ripple effect that impacts the entire industry. It will be interesting to see how this situation develops and what measures other crypto-friendly banks may take to reduce their exposure to such risks in the future, writes Shonal Rath.

On Friday, the global cryptocurrency market experienced a decline of 4% in its market cap, with Bitcoin falling by 4.5% to $22,386, and Ethereum trading below the $1,600 level. The global crypto market cap is currently valued at $1.03T. The market’s decline can be partly attributed to the financial distress of Silvergate Bank, a California-based crypto bank that is facing several challenges since early 2023

Source: MarketCoinCap

In this article, we will examine:

  • the reasons for the bank’s challenges
  • why crypto-friendly banks such as Silvergate are essential for mainstream adoption of cryptocurrency
  • the potential impact on the broader crypto market

The reasons for the bank’s challenges

Why has Silvergate Bank hit the headlines now? The bank recently announced that it would delay its annual 10-K financial report filing. Last week, the bank revealed in its disclosure to the Securities and Exchange Commission that its health could be threatened by investigations from banking regulators. Global ratings agency Moody’s downgraded Silvergate Capital Corp’s deposit rating to ‘Caa1’ from ‘Ba3’ on Friday.

According to media reports, Silvergate has been facing several challenges since the early months of 2023. The bank has reportedly dismissed nearly 40% of its workforce and shelved various projects. Additionally, US Senators Elizabeth Warren, Roger Marshall, and John Kennedy have raised concerns about Silvergate’s alleged inside knowledge of the FTX fraud. The senators have urged for transparency and information on Silvergate’s role in the FTX collapse, particularly given the fact that Silvergate turned to the Federal Home Loan Bank as its lender of last resort in 2022.

The fear ignited by this development sparked swift reactions from Silvergate’s big-name clients, like Coinbase (COIN), Paxos, Circle Internet Financial, and Galaxy Digital, which moved to sever ties.

Media also reported that recently, cryptocurrency derivatives exchange LedgerX, which is part of the bankrupt FTX group, advised its clients to stop using Silvergate for domestic wire transfers and instead focus on Signature Bank. Last year, Silvergate’s customers withdrew $8 billion following the fall of FTX. The bank’s stock has fallen 90% in the last 12 months.

Investors are concerned about the risk of contagion effects that could affect the financial stability of other institutions, given the current regulatory uncertainty and the potential for the Federal Reserve to increase interest rates. As a result, banks that are friendly towards cryptocurrency may be considering reducing their exposure to it in the short term. Signature Bank, which took over from Silvergate as Coinbase’s banking partner, already did so during the bear market peak in the previous year. However, with the possibility of further regulations being introduced, they may be under even more pressure to do so.

Why crypto-friendly banks such as Silvergate are essential for mainstream adoption of cryptocurrency?

Silvergate and institutions like it are critical for the mainstream adoption of crypto. Crypto is separate from traditional finance (TradFi), but it still relies on regulated banking partners to bring fiat currencies in and out of the crypto system. Silvergate has been a go-to bank for the biggest crypto players. However, since the collapse of FTX, it has come under fire. Around a dozen crypto firms it partnered with have now been shut down or fined. These include names like Celsius and Voyager Digital.

The firm said it sold additional debt securities to repay financial obligations and that further losses could make the bank “less than well capitalized.” Silvergate, which reported a $1 billion loss in Q4 2022 prompted by the demise of FTX, is currently evaluating the impact of its recent issues and regulatory challenges and will fail to submit its annual report due in mid-March.

Potential impact on the crypto market

Without strong crypto-friendly banks, mainstream crypto adoption will become much more difficult. The situation with Silvergate is a concern for the crypto market, and it will be important to see how this situation develops.

Bitcoin is down about 5% today to $22,400, which is below its 21-day moving average and halted short-term momentum. The asset is searching for support, which it could find at $21,500 or $20,700. Even with the pullback over the last two weeks, Bitcoin is still up 35% year to date. As the market leader, it will be important for Bitcoin to hold its ground. Any weakness would likely cause a greater swing for altcoins.

Ethereum is also down 5% in today’s trading, hovering slightly below $1,600. The second-largest crypto by market cap has mostly mirrored Bitcoin’s performance recently, but it saw larger positive bounce backs during the green days this week. Ethereum also dipped below its 21-day moving average today and lost short-term momentum, but it could find support at its current trading level. If not, the next potential support level is at $1,500. ETH has mostly traded in a neutral direction since late-January, but the asset’s early January run heavily contributed to its 32% year-to-date gain.

As the crypto market has been gaining momentum, investors are becoming increasingly aware of the potential risks associated with investing in digital currencies. Regulatory uncertainty and the possibility of the Federal Reserve hiking interest rates have left investors worried about the potential contagion effects that could impact the solvency of other exposed institutions.

In response, banks that have been friendly towards cryptocurrency are now considering reducing their exposure to it in the near term. For instance, Signature Bank, which replaced Silvergate as Coinbase’s banking partner, had already reduced its crypto exposure during the height of the bear market last year. This decision could have been influenced by the bank’s desire to avoid the risks associated with investing in a volatile market.

The possibility of further regulatory scrutiny in the future may exacerbate this trend. Banks that are currently accommodating towards crypto may face additional pressure to reduce their exposure to digital currencies, as regulators seek to ensure that these institutions are not taking on excessive risk.

Conclusion

Nonetheless, the industry is buzzing with new innovations and use cases. Notably, Ethereum successfully rolled out the Shapella upgrade on the Sepolia testnet, paving the way for unstaking on its mainnet soon. Investors can also look forward to improved scaling through sharding, which is a way of splitting the network into shards to lessen congestion. This could happen later this year. Polygon has recently introduced a new product called Polygon ID, which is based on Zero-Knowledge (ZK) technology. This innovative product allows users to verify their identities or credentials without revealing sensitive information.

Silvergate Bank and similar institutions are critical for the mainstream adoption of cryptocurrencies. Their potential insolvency or regulatory investigations could lead to a ripple effect that impacts the entire industry. It will be interesting to see how this situation develops and what measures other crypto-friendly banks may take to reduce their exposure to such risks in the future.

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