Banking Solutions for the Crypto Industry: Navigating the Fallout and Embracing the New Reality

The banking landscape within the cryptocurrency industry has experienced a whirlwind of changes in recent times, particularly with the unexpected closures of notable players like Signature Bank and Silvergate. Let's revisit some memorable quotes:

"We are confident in our financial strength and stability and remain committed to providing exceptional banking services to our valued customers." - Signature Bank CEO, shortly before the bank's closure.

"Our bank is built on a solid foundation of sound financial practices, and we are well-prepared to navigate any challenges that may arise." - Silvergate Bank spokesperson, assuring customers of the bank's stability prior to its wind-down.

We were once clients of Silvergate and endured a painstaking four-month account opening process, due to their thorough due diligence. Despite the wait, it seemed worth it as we trusted their status as a major player in the crypto industry and a safe choice. Then, when Valmar contacted Silvergate in Q4 2022 to get the scoop on what was happening post FTX, their response was essentially, "Don't worry, everything is fine, our balance sheet is strong, and we can handle all the craziness going on with crypto and FTX." Shortly after, Silvergate Bank voluntarily wound down its operations after being embroiled in a maelstrom of controversy. The bank's association with FTX and Alameda Research triggered a run on its services, ultimately leading to its closure. It seemed they applied different due diligence standards for different clients, and clearly didn't anticipate just how quickly things can go south in the banking world.

This event sent shockwaves throughout the industry, as Silvergate had long been trusted as a reliable provider of banking services for cryptocurrency businesses. Adding to the confusion, Signature Bank, another US-based stalwart crypto bank, suddenly closed for reasons that remain a little unclear. Add Silicon Valley Bank to the mix, and it just felt like the banking world was falling apart.

However, the reality is that despite their fancy reputation, Silvergate and Signature were relatively small regional banks, each with deposits ranging from $10 to $20 billion, hardly the kind of collapse that would bring the financial system crashing down. Their closures may have caused anxiety among industry players, but viable banking alternatives exist, ensuring that the crypto industry continued to thrive.

Alternative Banking Solutions

The closure of Signature Bank and Silvergate may have created some turbulence in the crypto industry, but it was by no means insurmountable. Several US banks have emerged as strong contenders to fill the void, alongside numerous foreign banks. In fact, through our relationships with the Alternative Investment Management Association (AIMA), the Global Digital Currency Association (Global DCA), and other industry groups and market participants, we have compiled an extensive list of nearly 50 banks in the US and offshore, including many FDIC-insured US banks. The Valmar team has taken the initiative to personally engage with a few institutions directly, including but not limited to Citizens Bank, Customers Bank, Mercury, Northern Trust, Western Alliance Bank, BCB Group, Axos Bank, Fifth Third Bank, SEBA, and Sygnum. Through our interactions, we have discovered that many of these banks not only have the potential to step in and offer vital banking services to crypto businesses, ensuring seamless operations and transactions, but in many cases, they are already doing so, and often possess stronger balance sheets and more comprehensive insurance solutions compared to Silvergate and Signature.

Admittedly, the closures of Silvergate and Signature also raised concerns about the loss of convenience and speed provided by Signet and the Silvergate Exchange Network (SEN). Signet, from Signature Bank, was a digital payment platform for cryptocurrency transactions, offering instant fiat transfers. SEN provided a similar service, facilitating quick and free USD transfers between Silvergate accounts and network participants. Both platforms enhanced liquidity and streamlined fund transfers in the crypto industry. Even here, however, the crypto industry has demonstrated strong resilience and adaptability, as alternative solutions have been emerging to fill this void and ensure uninterrupted transaction facilitation. For example, several banks are implementing networks essentially similar to SEN and Signet, while stablecoin transfers enable the industry to maintain seamless payment processes and facilitate transactions around the clock, 365-days a year.

One significant advantage of this evolving banking landscape is the opportunity for the crypto industry to develop a more diverse and robust set of banking solutions. Previously, the industry had become overly reliant on just two major players, exposing itself to concentration risk. By expanding the range of available banking partners, the industry can more effectively distribute risk, enhance stability, and foster healthy competition.  

Due Diligence Considerations

Having a variety of options in the banking landscape is undoubtedly encouraging. However, it is equally important to conduct comprehensive due diligence prior to selecting your banking partner, and assess factors such as stability, risk exposure, and profitability. Additionally, many conversations with our peers have revealed that opening multiple bank accounts is a common practice, providing added security and flexibility in managing financial transactions.

Here are some of the key due diligence considerations:

1. % of Deposits FDIC Insured: This metric indicates the percentage of deposits that are protected by the FDIC, currently providing insurance coverage of up to $250,000 per account. A lower percentage suggests that a larger portion of deposits is at risk of being withdrawn if the bank experiences stress.

2. Tier 1 Capital/RWA: The Tier 1 Capital ratio compares a bank's equity to its risk-weighted assets (RWA) and reflects the amount of capital available to absorb losses. A higher ratio indicates a stronger capital buffer.

3. Held-To-Maturity / Total Deposits: This metric focuses on the bank's holdings of U.S. Treasuries and agency mortgage-backed securities (MBS) designated as held-to-maturity (HTM). During times of stress, banks may be forced to sell these assets, leading to potential losses. The recent experience of Silvergate, Silicon Valley Bank, and Signature underscores the importance of managing HTM securities. To address this, the Federal Reserve has introduced a credit facility that allows banks to collateralize their U.S. Treasuries and agency MBS, mitigating potential losses.

4. Net Loans / Total Deposits: This ratio evaluates the bank's exposure to the duration and liquidity mismatch between borrowed short-term deposits and long-term loans. In times of deposit withdrawals, banks may need to liquidate loans to meet the demand. However, loans are less liquid than securities and cannot be easily pledged for liquidity. A higher net loans to total deposits ratio indicates a higher vulnerability to liquidity crises stemming from an illiquid loan portfolio. In addition, whole loans are currently not eligible collateral at the Fed discount window. Certain mortgage loans are eligible collateral at the Federal Home Loan Bank System but have higher haircuts.

5. Return on Equity (ROE): ROE measures a bank's profitability and is an annualized figure. A higher ROE signifies greater profitability, although exceptionally positive values may indicate excessive risk-taking. Negative ROE suggests the bank incurred losses during the previous year, often due to provisioning for potential losses.

6. Credit Rating: While rating agencies have earned a lot of criticism, particularly in the wake of the financial crisis, having a favorable credit rating does offer the added benefit of some level of 3rd party diligence and confers the institution easier access to funding from capital markets. All else being equal, it makes sense to favor a banking partner that has a high credit rating from an established rating agency.

Conclusion

Looking ahead, as regulatory clarity improves and the crypto industry continues to mature, larger banks will undoubtedly enter the scene and provide comprehensive banking services to the industry. However, in the interim period, the availability of alternative banking partners is crucial for the industry's growth and stability. These partners have swiftly stepped in and filled the gap left by the closures of Signature Bank and Silvergate, allowing the industry to maintain its upward trajectory. With time, experience, and increased regulatory certainty, the crypto industry will witness a gradual shift toward a more inclusive and integrated banking ecosystem.  Please contact Valmar if we can make useful banking introductions for you.

-The Valmar Team