Silvergate Capital Faces Questions During FTX Crypto Crash

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

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

Silvergate’s stock price plunged nearly 89% from a 12-month high of $162.87 last December, closing at $18.73 on the New York Stock Exchange on Tuesday.

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,” said the letter, also signed by Republican 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 said.

The letter calls on Silvergate to provide answers to a number of specific questions by December 19.

In a statement, Silvergate responded 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.”

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

But Lane says 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 from short sellers, who are betting that 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 revelations of insufficient financial controls that led to client funds being funneled into risky investments made by Alameda Research without their knowledge.

The potential losses to investors are unclear, but could be in the billions.

FTX founder Sam Bankman-Fried was arrested in the Bahamas on Monday. US prosecutors on Tuesday charged Bankman-Fried with a string of financial crimes and campaign finance violations, claiming he played a central role in the collapse of FTX and hid his troubles from the public and investors. The US Securities and Exchange Commission also filed civil fraud charges against Bankman-Fried on Tuesday.

Wedbush Securities analyst David Chiaverini says Silvergate could face a fine from regulators and a class action lawsuit from FTX clients or investors who have lost money. But he thinks these possible scenarios could be expensive but should be manageable for the bank.

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

Silvergate’s primary business is to facilitate payments between cryptocurrency hedge funds and cryptocurrency exchanges. 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, about $1.9 billion of Silvergate deposits had left the bank at the end of the September quarter.

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 have created this business specifically to support our clients not only during periods of growth but also in times of volatility – meaning our business is designed to accommodate deposit inflows and outflows across a range of market conditions.”

Add a Comment

Your email address will not be published. Required fields are marked *