Silvergate: from the small local lender to the bank behind the crypto boom

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

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

Silvergate was an unlikely candidate to be the bank behind the $40 billion cryptocurrency that collapsed 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 assets.

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

Deposits increased from about $2 billion in 2020 to more than $10 billion in 2021. Total assets rose to $16 billion this year. In late 2019, just 10 months after listing on the New York Stock Exchange, Silvergate’s stock price exceeded $200 at $12 per share.

“It was a small real estate lender that was involved in cryptocurrency,” one former employee said. “It was totally weird.”

But that rollercoaster came to a screeching halt last week when Silvergate collapsed to the chagrin of US senators investigating the failure of Bankman-Fried’s FTX, which is now accused of mismanaging customer deposits with losses of up to $10 billion.

According to a letter sent by US senators to the bank’s CEO Alan Lane, Silvergate appears to be “at the center” of how these funds are moved around Bankman-Fried’s crypto empire. Failure to detect such a “scheme” could mean Silvergate was in breach of anti-money laundering laws, he said.

Lane sought to address market concerns about its relationship with FTX in an open letter last week accusing short sellers of spreading “speculation” and “misinformation.” According to him, the bank “conducted significant due diligence on FTX and its related institutions”.

Silvergate quietly removed its glowing tribute to Bankman-Fried from its website, along with a reference to its former client. FTX’s bankruptcy wiped out two of the bank’s best clients: FTX owned about 10 percent of Silvergate’s total assets, and its clients included cryptocurrency BlockFi, a major victim of the crisis. FTX and its “related entities” had about 20 different accounts at Silvergate, according to the bankruptcy filing.

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

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

Hired by Silvergate founders Dennis Frank and Derek Eisele when the bank collapsed in 2008, Lane planned to turn it into a full-service commercial bank, people close to the business said. He previously turned around a number of small local banks.

But in 2013, Lane started dabbling in crypto. Bitcoin, then a fledgling four-year-old technology, hit a record high that year, rising almost 7,000 percent to surpass $1,000 for the first time. Crypto slowly began to gain mainstream information.

“We needed escrow, and Alan started to see companies like Coinbase being kicked out of banks,” said Ben Reynolds, president of Silvergate, who was hired by Lane in 2016 to turbocharge its cryptocurrency strategy. “So the idea was: if we can bank 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 said ok.

Large financial institutions, wary of the emerging asset class linked to money laundering and illegal drugs, have refused to bank cryptocurrencies and have begun blocking customer transfers to buy cryptocurrencies. Traditional banks were also not set up for crypto traders who needed to be able to transfer money on weekends.

Lane and Reynolds recognized a gap and inefficiencies in a rapidly growing market and seized the opportunity, according to a former employee. “The two of them in the same room just blew up,” he said. “The founders of Silvergate were both real estate people, but they loved it [the change in direction] because he was making money.”

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

In 2017, they launched the Silvergate Exchange Network, or SEN platform, which allows cryptocurrency investors to transfer US dollars from their bank accounts to a cryptocurrency exchange instantly and 24/7 as long as both the exchange and the investor bank with Silvergate.

Then in March of this year, Silvergate made a $200 million loan to a company owned by American crypto-billionaire Michael Saylor, the biggest step yet in issuing Bitcoin-backed US dollar debt.

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

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

“When they got into it, cryptocurrency was this little new thing and I think they didn’t know it was going to take off so fast,” said a person close to the business. “So they put all the chips in that direction, it ran away from them, it grew very quickly.”

As lawmakers pick apart Silvergate’s ties to FTX, the bank will have to scrutinize its exposure to an unregulated industry where the risk of fraud and bad actors appears higher than ever.

“The bank has no real responsibility to prevent transactions between seemingly legitimate entities,” said a person close to Silvergate. “This goes to the heart of the lack of regulation of crypto companies. For example, there is no requirement for everyone to maintain a separate account with only client funds.

Silvergate’s share price has halved its level before the FTX collapse and is down almost 85 percent this year, although at $23 it is still more than double its IPO price. The bank faces significant uncertainty over its digital deposits, which have fallen 60 percent so far this quarter, according to analysts at Morgan Stanley. “The destruction of FTX could also lead to litigation and headline risk in the cryptocurrency ecosystem,” they said.

“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,” Reynolds said. “You have to ask the questions about where digital assets go from here, which is a pretty big reputational issue for the industry, those are the questions we’re asking.”

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