Top crypto bank faces big test on Wall Street

You can’t completely isolate cryptocurrencies, however risky and volatile, from the broader economy. Sooner or later, the two will come together.
Thomas Lee
Senior Writer, Digital Assets Group

Institutional investors have not yet flocked to cryptocurrencies, due in large part to how the Securities and Exchange Commission will regulate the emerging asset.

However, one high profile crypto institution already enjoys the (defacto) support of federal regulators and is now planning to go public.

Silvergate Capital, based outside of San Diego, recently filed paperwork for a $50 million initial public offering. That may not sound like a lot of money but it could foreshadow institutional appetite for the nascent crypto industry.

A regular bank but not a regular bank

Silvergate is not a pure crypto company but rather a commercial bank regulated by the Federal Reserve, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency. But the company is hardly a regular bank.

Over the past 5 years, Silvergate has established itself as perhaps the friendliest bank to the cryptocurrency industry, providing run of the mill banking services like deposits and money transfers to crypto exchanges, hedge funds, venture capital firms, and startups. Since crypto is inherently volatile and high risk, not a lot of banks are willing to take on such customers.

Silvergate does not actually take deposits in digital currencies but rather plain old fiat cash. But that cash is inherently linked to crypto given the company’s customer base.

Nearly half of its Silvergate’s total $1.593 billion in total deposits comes from crypto exchanges, including the 5 largest such exchanges in the United States like Coinbase in San Francisco, according to SEC documents.

So as crypto fortunes rise and fall, so does Silvergate.

“The digital currency market is volatile, and changes in the prices and/or trading volume of digital currencies may adversely impact our growth strategy and our business,” according Silvergate’s prospectus. “In particular, the impact that changes in prices and/or trading volume of digital currencies have on our deposit balance from customers in the digital currency industry is unpredictable.”

Like any other bank, Silvergate takes those deposits and invests the funds in other assets like deposits at other banks or mortgages. Unlike other banks, Silvergate pays its customers little or no interest on the deposits, mostly because other banks won’t take the risk. Non-interest-bearing deposits account for 88.2 percent of the company’s total deposits, SEC filings show.

Backed by Uncle Sam

But Silvergate enjoys a distinct advantage over pure play crypto institutions: the support of the federal government.

Like other commercial banks, Silvergate deposits are insured by the FDIC up to a certain amount. So should Silvergate go belly up, its crypto customers will get some of their funds back.

That means the feds could assume some of the industry’s liabilities and possibly make institutional investors more willing to buy the shares of a company backed by the full faith and credit of the United States government.

Looking forward, Silvergate might offer a model on how to meld the traditional financial system with the emerging digital currency industry.

Silvergate generates additional revenue by helping its customers transfer fiat to cryptocurrencies or vice versa. In fact, the company sees big growth opportunities in stablecoins, the cryptocurrency whose value is linked to the U.S. dollar on a 1:1 basis.

“We are already benefiting from our clients’ interest in stablecoins by holding fiat currency for our customers that may ultimately be exchanged for stablecoins,” the company said in its prospectus. “Fiat currency held for customers that may be used for exchanging into stablecoins is not treated any differently than other fiat currency held by the Bank’s depositors.”

Moreover, banking is a highly regulated business and the crypto industry really needs some regulation if it wants to attract money from institutional investors. Silvergate’s business model demonstrates that you can’t completely isolate cryptocurrencies, however risky and volatile, from the broader economy.

Sooner or later, the two will come together.