La Jolla-based Silvergate Capital Faces Questions From US Lawmakers Over Collapse of Crypto Exchange FTX

La Jolla-based Silvergate Capital has made a name for itself in recent years as one of the few mainstream banks providing deposits, fund transfers, security, and other services for the cryptocurrency trading market.

But two high-profile cryptocurrency bankruptcies, one of which is alleged to involve fraud, have rocked the small financial institution’s shares and caught the attention of lawmakers.

Silvergate’s stock price closed Dec. 14 at $18.71 a share on the New York Stock Exchange, an 88% drop from last December’s 12-month high of $162.87.

Silvergate’s primary business is to facilitate payments between cryptocurrency hedge funds and cryptocurrency exchanges.

US Senator Elizabeth Warren, D-Mass and two other senators sent a letter to Silvergate CEO Alan Lane last week raising questions about the California-incorporated bank’s safeguards on accounts at cryptocurrency exchange FTX and its own sister trading firm Alameda Research.

“Your bank’s involvement in the transfer of FTX customer funds to Alameda reveals what appears to be a major failure of your bank’s responsibility to monitor and report suspicious financial activity conducted by its customers,” according to the letter, also signed by The Republicans John Kennedy of Louisiana and Roger Marshall of Kansas. Warren and Kennedy are members of the Senate Banking Committee.

“The public owes a comprehensive accounting of the financial activities that may have led to the loss of billions in customer assets and any role Silvergate may have played in these losses,” the senators wrote.

The letter requests Silvergate to provide answers to a number of specific questions by Monday 19 December.

Silvergate said in a statement that it intends to meet the senators’ requests within legal limits.

“As a regulated bank, we remain committed to our banking secrecy/anti-money laundering obligations and look forward to answering Senator Warren’s questions as openly and transparently as possible,” the statement said.

Lane responded separately in a Dec. 5 letter to the bank’s shareholders: “It’s been a very tough few weeks for the digital assets industry as we’ve all grappled with the apparent misuse of client assets and other lapses in judgment.” by FTX and Alameda research.

But Lane said Silvergate carried out “significant due diligence” and ongoing monitoring of FTX and Alameda Research’s accounts at the bank, handling wires in accordance with senders’ instructions and industry practice.

He added that short sellers are spreading misinformation about the bank’s role in spotting FTX/Alameda problems. Interest in the stock by short sellers, who bet the price will fall, was up 97% in November compared to October.

FTX collapsed last month and filed for Chapter 11 bankruptcy. Its financial health has been called into question after allegations of poor financial controls that led to client funds being funneled into risky investments made by Alameda Research unbeknownst to them.

The potential losses to investors are unclear, but could be in the billions. FTX founder Sam Bankman-Fried, who also controlled Alameda Research, was arrested Dec. 12 in the Bahamas. On December 13, the US Securities and Exchange Commission filed civil fraud charges against Bankman-Fried.

Wedbush Securities analyst David Chiaverini said Silvergate could face a fine from regulators and a class action lawsuit from FTX clients or investors who lost money. He said he thinks these scenarios could be costly but manageable for the bank.

At least two lawsuits have already been filed by Silvergate shareholders alleging that the bank made misleading statements to its investors. Both seek class action status.

In a research report released last month, Chiaverini wrote that he doesn’t think Silvergate is at fault for handling FTX’s funds.

“Silvergate did what banks do: it facilitated payments between two willing parties where neither party was active [a U.S.] sanctions list or other restriction list, nor were the payments abnormal for the businesses in which the parties operate,” Chiaverini wrote.

“Alameda Research is a big cryptocurrency hedge fund and FTX is a big cryptocurrency exchange,” he said, “so it’s only natural that Silvergate would provide payment services to each.”

The volatility in the cryptocurrency markets started last summer as investors looked to de-risk amid the economy’s headwinds and the prices of digital currencies fell sharply.

Bitcoin, the best-known digital currency, has seen its value tumble 64% from a 2022 high. Digital currency lender BlockFi went bankrupt in the wake of the FTX implosion.

Silvergate does not own or trade the cryptocurrency itself. It provides many traditional banking services, including custody services, fund transfers, 24/7 US dollar transaction facilitation, customer account checks, and security, required to enable digital currency trading.

The result has been a growing pool of interest-free deposits that the bank can then use to fund loans or invest in other interest-bearing instruments, largely from institutional traders. At their peak, Silvergate’s deposits reached about $12 billion.

With the bankruptcies and other turmoil, some $1.9 billion of Silvergate deposits had left the bank by the end of September.

Silvergate says it has ample liquidity to deal with the decline. Its total deposits stood at $9.8 billion in mid-November. Day-to-day use of its US dollar exchange services for crypto traders hasn’t slowed down, according to the bank.

“We intentionally carry cash and securities in excess of our digital assets deposit liabilities,” Lane said in a statement. “We built this business specifically to support our clients not only during times of growth but also during times of volatility. That is, our business is designed to accommodate deposit inflows and outflows under a range of market conditions. ◆

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