Crypto Receives a Reminder of the Relevance of Banks

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The clo­sure of Sil­i­con Val­ley Bank last week has sparked a peri­od of unprece­dent­ed bank tur­moil last seen dur­ing the Glob­al Finan­cial Cri­sis (GFC) in 2008.

While 2020 was a night­mare year for most, it was a boom for the tech sec­tor. Peo­ple were spend­ing more time on their phones and com­put­ers, con­fer­enc­ing soft­ware came into its own, and new mon­ey and a hir­ing spree meant the sec­tor was more vibrant than almost any oth­er part of the economy. 

Sil­i­con Val­ley Bank (SVB), one of the lead­ing banks in the tech­nol­o­gy sec­tor, had $60 bil­lion in cus­tomer deposits in the first quar­ter of 2020 and $200 bil­lion by the first quar­ter of 2022. The good times weren’t to last.

Silicon Valley Bank Is the Largest Failure of a Bank Since 2008 

How­ev­er, the bank invest­ed in trea­sury bonds and mort­gage-backed secu­ri­ties but suf­fered grave loss­es when the Fed­er­al Reserve raised inter­est rates to com­bat ris­ing infla­tion. Sil­i­con Val­ley Bank sold assets to min­i­mize loss­es. But when it announced it need­ed to raise $2.25 bil­lion in cap­i­tal, clients with­drew $42 bil­lion in deposits. Reg­u­la­tors shut down the bank the fol­low­ing day. It’s the largest fail­ure of a U.S. bank since the GFC in 2008. 

How­ev­er, on Sun­day, the U.S. gov­ern­ment announced depos­i­tors would be able to access their cash from Mon­day. All depos­i­tors would be ful­ly pro­tect­ed, assuag­ing fears of a wider cri­sis. The U.S. Trea­sury, the Fed­er­al Reserve, and the Fed­er­al Deposit Insur­ance Cor­po­ra­tion (FDIC) have stat­ed that the tax­pay­er will not bear any loss­es from the move.

Mean­while, an offer has been made for SVB’s U.K. arm, with a con­sor­tium of investors led by the Bank of Lon­don sub­mit­ting a for­mal bid to the U.K. Trea­sury. The British gov­ern­ment has been work­ing on a plan to sup­port U.K. tech firms affect­ed by the col­lapse of SVB.

While Sil­i­con Val­ley Bank was not as exposed to cryp­to as Sil­ver­ware, it has already caused rup­tures across the industry.

USDC Depegged Following Silicon Valley Bank Collapse

The sta­ble­coin USD Coin (USDC) declined to a low of $0.879 on Coin­Mar­ket­Cap. Cir­cle, the com­pa­ny behind USDC, had $3.3 bil­lion of expo­sure to SVB, caus­ing con­cern among investors that the sta­ble­coin may not main­tain its peg to the U.S. dol­lar. Although the $3.3 bil­lion only makes up $40 bil­lion of total USDC reserves.

USDC Price Chart
Sta­ble­coin USDC drops to a low of $0.879 dur­ing the Sil­i­con Val­ley Bank clo­sure announce­ment. Source: Coin­Mar­ket­Cap

“Sil­i­con Val­ley Bank… has just suf­fered a clas­sic bank run, much like those we saw dur­ing the finan­cial cri­sis in 2008,” the com­pa­ny said in a blog post on Sat­ur­day. “$3.3bn of USDC’s cash reserves remain with SVB. As of Thurs­day, we had ini­ti­at­ed trans­fers of these funds to oth­er bank­ing part­ners. Though these trans­fers had not yet been set­tled as of close of busi­ness Fri­day, we remain con­fi­dent in the FDIC’s man­age­ment of the SVB sit­u­a­tion and stand ready to receive these funds.”

Why does a bank col­lapse affect the peg of a sta­ble­coin? In part because USDC is ful­ly reserved-backed. That means every USDC is backed by actu­al cash and short-dat­ed Unit­ed States trea­suries. If part of that reserve dis­ap­pears or goes missing—even temporarily—the mar­ket will lose con­fi­dence. Investors will wor­ry whether the sta­ble­coin can retain its value.

And then there’s Sil­ver­gate, whose col­lapse took place only days before the SVB turmoil.

Crypto-Friendly Banks Had a Nightmare Week

The bank, which had high-pro­file clients such as Coin­base, Gem­i­ni, Pax­os, and Cir­cle, blamed the col­lapse of Sam Bankman-Fried’s FTX exchange empire for its woes. The bank’s shares dropped 20% after the Jus­tice Depart­ment announced an inves­ti­ga­tion into its role in the col­lapse of FTX. 

Silvergate’s col­lapse has left a hole in the U.S. cryp­tocur­ren­cy indus­try, with many cryp­to exchanges strug­gling to move dol­lars into their trad­ing accounts and off-ramp them into their bank accounts. Com­pa­nies like Coin­base, Crypto.com, and Pax­os quick­ly dis­tanced them­selves from the bank. 

Unfor­tu­nate­ly for cryp­to, Silvergate’s implo­sion will like­ly draw more scruti­ny from law­mak­ers. There is grow­ing con­cern about the impact of the indus­try on tra­di­tion­al finance.

“As the impact of FTX’s col­lapse con­tin­ues to rip­ple out­ward, today we are see­ing what can hap­pen when a bank is over­re­liant on a risky, volatile sec­tor like cryp­tocur­ren­cies,” said Sher­rod Brown, a pro­gres­sive U.S. Sen­a­tor, and Chair of the Sen­ate Bank­ing, Hous­ing, and Urban Affairs Committee. 

“I’ve been con­cerned that when banks get involved with cryp­to, it spreads risk across the finan­cial sys­tem, and it will be tax­pay­ers and con­sumers who pay the price.”

After Sil­ver­gate announced its vol­un­tary liq­ui­da­tion, blockchain com­pa­nies turned to Sig­na­ture Bank. One of the last banks in the U.S. to offer finan­cial ser­vices to the volatile indus­try. How­ev­er, two days after the Sil­i­con Val­ley Bank col­lapsed, the New York Depart­ment of Finan­cial Ser­vices took pos­ses­sion of Sig­na­ture Bank, which has deposits total­ing $88.59 billion. 

For cryp­to com­pa­nies part­ner­ing with Sig­na­ture, the announce­ment brings imme­di­ate relief that their deposits will be pro­tect­ed. But it leaves the open ques­tion of where they will find bank­ing services.

What About the Bankless Future?

So what about the finan­cial-tech utopia that cryp­to promised? Why has the col­lapse of two banks sent the cryp­to mar­kets into a tail­spin? Wasn’t cryp­to sup­posed to sup­plant the tra­di­tion­al finan­cial system?

It was, or it still may do. That all depends on who you ask. How­ev­er, the cru­el fact is cryp­to still exists in a wider finan­cial sys­tem, of which tra­di­tion­al banks are a big part. And even if your cryp­to prin­ci­ples mean you want to avoid inter­act­ing with banks as much as pos­si­ble, the peo­ple who invest in your com­pa­ny, those who trade your token, and the oth­er busi­ness­es you work with, will have dif­fer­ent ideas.

The “ban­k­less” future many envi­sioned has almost come true this week. Although not quite how peo­ple imagined.

Of course, tra­di­tion­al retail bank­ing will be a must until you can pay for more goods and ser­vices in cryptocurrency.

Unfor­tu­nate­ly for the cryp­to max­i­mal­ists, tra­di­tion­al-style banks are the axles on which the wheel of the finan­cial sys­tem spins. When they go down, cryp­to is inevitably affected.

Also, DeFi sim­ply isn’t mature enough to replace banks yet entire­ly. The total DeFi mar­ket cap is less than 50 bil­lion dol­lars. Where­as the tra­di­tion­al finan­cial indus­try is mea­sured in tril­lions of dol­lars. Until that real­i­ty changes, the cryp­to indus­try will need to be mind­ful of the impor­tance of these finan­cial behemoths.

Disclaimer

All the infor­ma­tion con­tained on our web­site is pub­lished in good faith and for gen­er­al infor­ma­tion pur­pos­es only. Any action the read­er takes upon the infor­ma­tion found on our web­site is strict­ly at their own risk.

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