Silvergate: From Small Local Financier to Bank Behind Crypto Boom

“Life as a crypto company can be divided into pre-Silvergate and post-Silvergate,” Sam Bankman-Fried wrote in a quote featured on the San Diego bank’s website that he used to transfer client funds to his FTX digital asset exchange. .

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

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

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

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

Deposits increased from around US$2 billion in 2020 to over US$10 billion in 2021. This year, total assets had jumped to US$16 billion. Just ten months after listing on the New York Stock Exchange in late 2019 at $12 a share, Silvergate’s stock price has soared to over $200.

“This was a small real estate lender that went all-in on cryptocurrency,” said one former employee. “It was completely weird.”

But the rollercoaster came to an abrupt halt last week, with Silvergate in the crosshairs of US senators investigating the bankruptcy of Bankman-Fried’s FTX, which has been accused of mishandling customer deposits now facing losses of up to $10 billion.

Silvergate “appears to be at the center” of how those funds were moved by 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 violated anti-money laundering laws.

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

Silvergate has quietly removed Bankman-Fried’s glowing tribute from its website, along with all references to its former client. The FTX collapse wiped out two of the bank’s main clients: About 10% of Silvergate’s total assets belonged to FTX, and its clients included cryptocurrency lender BlockFi, one of the main victims of the collapse. FTX and its “related entities” maintained about 20 different accounts at Silvergate, according to their bankruptcy filings.

The bank has until Dec. 19 to respond to the letter and provide a “complete accounting of its relationship with FTX.”

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

Hired by Silvergate founders Dennis Frank and Derek Eisele in 2008 when the bank was struggling, Lane planned to turn it into a full-service commercial bank, according to people close to the business. He had already bypassed a number of small local banks.

But in 2013 Lane started to get interested in cryptocurrencies. Bitcoin, then a four-year-old nascent technology, had a record high that year, rising nearly 7,000% to reach $1,000 for the first time. Cryptography was slowly making its way into the mainstream.

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

Wary of an emerging asset class that was linked to money laundering and illegal drugs, major financial institutions refused to trade cryptocurrencies and began blocking customer transfers to purchase cryptocurrencies. Traditional banks were also unprepared for cryptocurrency traders, who needed to transfer money on weekends.

Lane and Reynolds identified 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 realtors, but they loved [a mudança de direção] because it made money.”

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

In 2017, they launched the Silvergate Exchange Network, or SEN, a platform that allowed cryptocurrency investors to transfer US dollars from their bank accounts to an exchange instantly and 24/7, as long as the exchange and investor were Silvergate banking customers.

Then, in March of that year, Silvergate issued a $200 million loan to a company owned by US cryptobillionaire Michael Saylor, its biggest-ever step towards borrowing US dollars secured by bitcoin.

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

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

“When they got into it, cryptography was a new little thing, and I don’t think they realized it would take off as quickly as it did,” said one person close to the company. “So they put all the chips in that direction, the thing got away from them, it got too big too quickly.”

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

“The bank has no real responsibility to prevent transactions between entities that appear to be legitimate,” said a person close to Silvergate. “This is what goes to the bottom of there not being enough regulation for cryptocurrency companies. For example, there is no requirement that someone has to maintain a segregated account that only has client funds.”

Silvergate’s share price has fallen to half its level before the FTX collapse and is down nearly 85% this year, though at $23 it’s still nearly double its IPO price. The bank faces significant uncertainty over its digital deposits, which have fallen 60% so far this quarter, according to analysts at Morgan Stanley. “The demise of FTX could also spark litigation and securities risk across the cryptocurrency ecosystem,” they added.

“We had a plan for the year that was challenged by the current environment, and we’re still trying to come to terms with what happened,” said Reynolds. “You have to ask these questions where do the digital assets go from here. This is a big reputation issue for the industry, these are the questions we’re asking.”

Translated by Luiz Roberto M. Gonçalves