How Silvergate Went Bust
Posted March 09, 2023
Founded in 1986, Silvergate (SI) is a publicly-traded bank that was, for decades, just a small community bank in La Jolla, California.
By the way, La Jolla is a popular place to buy a vacation home if you’re into things like drug and human trafficking.
Because it’s close to Tijuana, La Jolla has been a money laundering hotspot for decades.
(Who knows… this might prove relevant in the days and weeks to come as the Silvergate saga unfolds.)
And then came crypto.
In anticipation of the 2020-2021 crypto bull market, Silvergate developed a proprietary tech platform -- Silvergate Exchange Network (SEN).
SEN boasted 24/7 uptime with instant fiat transfers, making it the go-to bank for crypto.
It proved to be a shrewd move.
By 2021, SEN was used to connect more than 1,600 crypto exchanges, financial institutions, hedge funds, and retail participants.
They grew fast.
SI’s total deposits went from $2 billion in Q1 2020 to $14.3 billion in Q4 2021.
And it was a sweet deal for Silvergate.
Crypto depositors were willing to hold their fiat with Silvergate at no cost in return for access to the SEN network.
BUT, here’s where things went sour…
What Went Wrong
In 2021, as Silvergate’s balance sheet ballooned during the crypto bull, the bank bought up billions in long-term US Treasury bills.
Unfortunately, they did so during a time of historically low interest rates.
When the Fed increased rates, those Treasuries became worth less on the bond market. In fact, by the end of Q3 2022, Silvergate had over $1 billion in unrealized losses.
It wasn’t ideal, but it would only prove catastrophic if Silvergate was forced to sell.
But you know what happened next: FTX.
Yes, Silvergate was forced to sell.
The Bank Run
On November 11, 2022, FTX filed for Chapter 11 bankruptcy.
When news hit that Silvergate had exposure, depositors got spooked.
Panicked, they withdrew their funds and deposits declined $8 billion, down 68% in one quarter.
Silvergate was forced to unload $6 billion of securities that it bought over the past two years for $7 billion.
That’s why there’s a ~$1 billion hole in the balance sheet.
Funny thing is…
This was easy to avoid.
Had they simply stayed in cash and short-term treasuries, they would’ve been fine.
This is how USDC -- the second-largest stablecoin -- can promise a 1-to-1 exchange for US dollars even during a run on the stablecoin.
Circle, USDC’s issuer, keeps 20% cash and 80% highly liquid 3-month T-bills.
(USDC’s reserve structure is more conservative than all major banks.)
People will blame crypto for Silvergate’s demise, but here’s the truth:
Silvergate had little to do with crypto and everything to do with Biblically bad risk management.
Simple as that.