Silvergate: From Small Local Lender to Bank Behind the Crypto Boom

“The life of a crypto business can be split between pre-Silvergate and post-Silvergate,” Sam Bankman-Fried wrote in a quote posted on the San Diego bank website he used to transfer client funds. to its digital asset exchange FTX.

“It’s hard to overstate how much this has revolutionized banking for blockchain businesses.”

Silvergate was an unlikely candidate to become the bank behind the $40 billion crypto exchange that collapsed into bankruptcy last month.

For most of its 30-year history, it was a small community lender focused on financing small real estate transactions, with three branches in Southern California and less than $1 billion in business. assets.

But in 2019, it was quickly becoming the largest cryptocurrency bank in the United States, with 1,600 of the world’s top crypto miners, exchanges and custodians using it to deposit and transfer billions of dollars every month.

Deposits grew from around $2 billion in 2020 to more than $10 billion in 2021. That year, total assets jumped to $16 billion. Just 10 months after it floated on the New York Stock Exchange in late 2019, at $12 a share, Silvergate’s share price had soared to more than $200.

“He was a small real estate lender who got into crypto,” said a former employee. “It was completely weird.”

But the roller coaster came to an abrupt halt last week with Silvergate caught in the crosshairs of US senators investigating the failed FTX of Bankman-Fried, which has been accused of mishandling deposits from customers who are now facing $10 billion in losses.

Silvergate “appears to be at the center” of how these funds were moved into Bankman-Fried’s crypto empire, according to a letter from US senators to the bank’s chief executive, Alan Lane. He said failure to detect such a “scheme” could mean Silvergate broke anti-money laundering laws.

Lane attempted to address market concerns about his ties to FTX in a public letter last week that accused short sellers of spreading “speculation” and “misinformation.” He said the bank had performed “significant due diligence on FTX and its related entities.”

Silvergate has quietly removed Bankman-Fried’s glowing tribute from its website, along with any references to its former client. The collapse of FTX wiped out two of the bank’s top clients: About 10% of Silvergate’s total assets belonged to FTX, and its clients also included crypto lender BlockFi, a major fallout victim. FTX and its “related entities” held about 20 different accounts at Silvergate, according to its bankruptcy filings.

The bank has until December 19 to respond to the letter and provide a “full account of its relationship with FTX.”

Lane, a 60-year-old devout Catholic and grandfather of more than 20 who lives in Temecula, Calif., is the mastermind behind Silvergate’s remarkable shift in strategy over the past few years.

Hired by Silvergate founders Dennis Frank and Derek Eisele in 2008 as the bank floundered, Lane planned to turn it into a full-service commercial bank, according to people familiar with the business. He had previously revolved around a chain of small local banks.

But in 2013, Lane started getting into crypto. Bitcoin, then a four-year-old nascent technology, hit a record high that year, rising nearly 7,000% to top $1,000 for the first time. The crypto was slowly starting to gain notoriety.

“We needed deposits and Alan started to see companies like Coinbase getting kicked out of the banks,” said Ben Reynolds, president of Silvergate who was hired by Lane in 2016 to boost his crypto strategy. “So the idea was, if we can bank Coinbase, we can find deposits. Alan went to the Federal Reserve and said we wanted to provide basic banking services to bitcoin companies and they said OK .

Wary of an emerging asset class that had been linked to money laundering and illegal drugs, major financial institutions refused to bank crypto exchanges and began blocking transfers by customers to buy coins. cryptocurrencies. Traditional banks were also not designed for crypto traders, who needed to be able to transfer money on weekends.

Lane and Reynolds recognized the gap and inefficiency in the fast-growing market and seized the opportunity, according to the former employee. “The two in the same room just exploded,” he said. “The founders of Silvergate were both real estate professionals, but they loved [the change in direction] because it made money.

Over the next six years, Lane and Reynolds sold Silvergate’s corporate banking team and downsized its real estate group. Its crypto customer base grew from around 20 companies in 2016, including Xapo, Paxos and Bitfury, to more than 1,000 and its management began exploring riskier ways to bolster its balance sheet, including launching a stablecoin. and structuring loans against cryptocurrencies.

In 2017, they launched the Silvergate Exchange Network, or SEN, a platform that allowed crypto investors to transfer US dollars from their bank accounts to a crypto exchange instantly and 24/7, provided that the exchange and the investor do business with Silvergate.

Then, in March this year, Silvergate provided a $200 million loan to a company owned by US crypto billionaire Michael Saylor, its biggest milestone ever in lending US dollars backed by Bitcoin.

“Alan saw this opportunity in crypto, which I still don’t fully understand, and he built it into something that’s quite an operation,” said his mentor, former boss and Silvergate investor Frank Mercadante.

But it was full of risks. Silvergate had to employ twice as many compliance staff as comparable banks of its size, according to two people who worked there. It usually takes six months for a new crypto exchange to open a bank account. “The main risks are know your customer and anti-money laundering and these were seriously considered in 2014” – when Silvergate won its first crypto client – ​​said one of the people. In June 2021, Silvergate ended its relationship with Binance, the world’s largest crypto exchange, for undisclosed reasons.

“When they got started, crypto was a bit of a novelty, and I don’t think they realized it would take off so quickly,” a person familiar with the company said. “So they put all the chips in that direction, it ran away from them, it got really big really quickly.”

As lawmakers examine Silvergate’s relationship with FTX, the bank will be forced to examine its exposure to an unregulated industry where the risk of fraud and bad actors seems higher than ever.

“The bank has no real responsibility to prevent inter-entity transactions that appear legitimate,” a person familiar with Silvergate said. “This is what is at the heart of the fact that there is not enough regulation of crypto businesses. For example, there is no requirement for anyone to keep a separate account that only has customer funds.”

Silvergate’s stock price has halved from its pre-FTX crash level and is down almost 85% this year, though at $23 it’s still almost double its level. IPO price. The bank faces significant uncertainty over its digital deposits, which are down 60% so far this quarter, analysts at Morgan Stanley said. “FTX’s demise could also lead to litigation and headline risk in the crypto ecosystem,” they added.

“We had a plan going into the year that was challenged by the current environment, and we’re still trying to come to terms with what happened,” Reynolds said. “You have to ask yourself these questions, where do digital assets go from here, it’s a pretty huge reputational issue for the industry, these are questions we’re asking.”

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