The good news about the collapse of Sam Bankman-Fried’s cryptocurrency empire is that its failure did not send shock waves through the entire financial system and create a contagion. A key reason is that most banks have refused to deal with crypto. Recently, U.S. banking regulators even discouraged them from doing so.
But one small California bank apparently decided it was better to risk having to beg for forgiveness than wait for permission. In recent years, La Jolla–based Silvergate went all in on crypto, forging relationships with more than 1,600 players in the industry, from hedge funds to exchanges to token projects. That includes alleged fraudsters like Bankman-Fried along with a slew of other sketchy companies and individuals who used Silvergate to move a trillion dollars into — and out of — crypto markets all over the world. With regulators and investors alike casting a sharper eye on the crypto world after the chaos of the past year, Silvergate now faces unanswered questions about its crypto products and its future business prospects in general.
The bank’s outsize role in the recent crypto bubble — and bust — is perhaps best described by Bankman-Fried himself. As the indicted FTX founder put it in a now-deleted testimonial on the bank’s website, “Life as a crypto firm can be divided up into before Silvergate and after Silvergate. It’s hard to overstate how much it revolutionized banking for blockchain companies.”
In the wake of FTX’s collapse, critics of the bank’s practices believe further regulatory scrutiny of that revolution will leave Silvergate in an unsustainable situation. “It was one of the biggest gateways from the banking system to the crypto business,” says Porter Collins, portfolio manager of Seawolf Capital and one of the figures in The Big Short. He thinks the crypto long-term bull market — and Silvergate’s role in it — is over, and he began shorting Silvergate last summer as the crypto meltdown gained speed. (The bank’s shares have plunged more than 80 percent over the past year.) Investor Marc Cohodes, an outspoken Silvergate short seller, argues that its customers demonstrate “a highly problematic pattern of potential criminal activity,” which will have negative repercussions for the bank.
Intelligencer has obtained documents showing that, in addition to FTX, Silvergate has been the go-to bank for more than a dozen crypto companies that ended up under investigation, shut down, fined, or in bankruptcy. These include the U.S. arm of Binance, the world’s largest crypto exchange, which Reuters has reported is under a criminal probe for money laundering, and a formerly Chinese-based offshore exchange (now with a Seychelles address) called Huobi whose CEO, Justin Sun, is likewise under investigation for money laundering, according to The Verge. Court documents show that Silvergate also did business with recently bankrupted crypto companies Voyager, Celsius, and BlockFi, while an online video shows crypto lender Nexo, which just agreed to a $22.5 million settlement with the Securities and Exchange Commission, directing customers to send money to a Silvergate bank account.
Silvergate also set up a dozen accounts for a since-convicted Australian crypto Ponzi artist, Stefan He Qin, according to an SEC complaint. And Bittrex, a cryptocurrency exchange and onetime Silvergate shareholder and customer that used to be featured on the bank’s website, has been sanctioned by U.S. authorities for moving money for places like Iran and Syria.
The bank simultaneously served large U.S.-regulated crypto firms. An internal Silvergate investor presentation obtained by Intelligencer shows it has been the bank for stablecoin issuer Circle — backed by Goldman Sachs — and publicly traded Coinbase.
Recently, a group of three senators, including Elizabeth Warren, has questioned whether Silvergate potentially facilitated FTX’s alleged fraud and has expressed skepticism that Silvergate was diligent about following anti-money-laundering and know-your-customer banking rules. Silvergate’s woes also appear to be the impetus for new regulatory guidance for banks that would crimp, if not end, the type of practices it is engaged in — and make it much harder for crypto players to bank elsewhere in the U.S. (A bank spokesperson declined to answer my question as to whether Silvergate is under investigation by the authorities or respond to the criticisms leveled against it.)
Meanwhile, some $10 billion in deposits from Silvergate’s crypto customers — more than 70 percent of the total as of late 2021 — were pulled from the bank in the past year. This run on Silvergate’s deposits is worse than any seen in the Great Depression, according to a Federal Reserve study.
“Everyone was scared; everyone was primed to fear counterparty risk,” says Ari Paul, the founder of BlockTower Capital, a crypto-investment firm that has banked with Silvergate for years. Paul declined to say whether BlockTower had yanked its funds, but he did say “it didn’t surprise me that you have that massive flight of capital out of Silvergate. Everyone like myself is feeling extra-conservative in how we think about risks.” He added that his firm is now looking for additional banking partners, but that may be a tough ask.
To Silvergate CEO Alan Lane, who joined the bank in 2008, the underbanked and novel crypto business looked like a surefire way to grow the bank’s deposits following the financial crisis. In a 2019 interview with crypto promoter Anthony Pompliano, Lane said his and Silvergate’s crypto journey began when he learned crypto companies were “getting kicked out of banks” over concerns about money laundering. By 2014, Lane had signed on Silvergate’s first crypto customer, Barry Silbert’s SecondMarket, which has since become crypto broker Genesis Trading and is part of the Digital Currency Group, a crypto conglomerate Silbert heads.
Silbert is facing his own woes in the train wreck that crypto has become over the past nine months. Genesis declared bankruptcy on Friday, and Cameron Winklevoss, co-founder of crypto trader Gemini, which has close to $800 million in customer funds with the firm, has called on Silbert to resign, accusing him of fraud. (After Bloomberg reported that Digital Currency Group was under investigation by federal prosecutors and the SEC, the latter charged both Gemini and Genesis with offering unregistered securities.)
In happier times, Silbert provided Silvergate with introductions to other crypto players that helped transform it from a sleepy local bank that had managed to avoid the 2008 housing crisis into something of a casino dealer for the crypto ecosystem. DCG was also the lead investor in a $114 million Silvergate private placement ahead of the bank’s IPO in 2019.
For all the antagonism crypto enthusiasts have toward “fiat” currency, they all still need and want access to old-fashioned dollars (or euros). “People aren’t native crypto users,” explains Hilary Allen, a professor of law at the American University Washington College of Law. “They start with their money in fiat currency, and when they get out of crypto, they want their money back in fiat currency. So in order to make that possible, there needs to be a relationship with the mainstream financial system.”
In the 2019 interview, a confident-sounding Lane, clad in the requisite black turtleneck à la Steve Jobs, explained that Silvergate soon provided its institutional crypto clients with what they desired — the ability to move money around 24/7 without “friction” — by creating what it called the Silvergate Exchange Network.
The easy trading fostered by SEN helped enable the 2021 crypto boom: Silvergate’s customers could even borrow from the bank against their bitcoin holdings to buy more crypto in its internal network. As of July, the bank said more than 20 percent of its loans were made through this program.
In creating SEN’s leverage product, however, Lane admitted it had not been blessed by regulators. “It’s not like it’s an approved product,” he said, a little-noticed comment made in a 2021 interview Silvergate had sponsored on an investor platform. “It’s a non-disapproved product.”
Silvergate has said that $1 trillion has changed hands on its network since the bank first allowed crypto businesses to deposit their dollars at its bank, which is insured by the Federal Deposit Insurance Corporation. Deposits at Silvergate peaked at $14 billion at the end of 2021, some 90 percent of which was from its crypto customers. But earlier this month, Silvergate disclosed that after the FTX debacle, its deposits had plummeted to $3.8 billion at the end of 2022. Forced to sell investments to cover the withdrawals, Silvergate lost nearly $1 billion last year — an amount that exceeds the bank’s profits since it entered the crypto business in 2014.
Silvergate is not a “too big to fail” bank, but it did get help from a government-sponsored entity. As first reported by The American Banker, Silvergate received $4.3 billion from the Federal Home Loan Bank of San Francisco late last year, according to recently released company filings. The crypto-friendly bank now holds roughly $4.6 billion in cash, the bulk of which came from Home Loan Bank advances. Silvergate also has access to taxpayer dollars through the Federal Reserve Bank of San Francisco.
A week before Bankman-Fried was arrested in the Bahamas, Senator Warren, along with Republican colleagues John Kennedy and Roger Marshall, asked pointed questions of CEO Lane about the bank’s handling of what are now alleged to be illegal transactions conducted by Alameda Research and FTX. The three wrote a letter to Lane noting the “bank’s failure to report these suspicious transactions.”
The heart of FTX’s alleged fraud is the misappropriation of customer deposits intended for the FTX Exchange, an offshore entity, into Alameda Research, Bankman-Fried’s hedge fund. According to the SEC, funds intended for FTX were deposited into the Silvergate account of an Alameda subsidiary called North Dimension in order to hide the fact that they were going to Alameda. North Dimension purported to be an online electronics retailer on a now-defunct website that appears to have been fake since nothing could be purchased on it.
After the FTX bankruptcy filing but before Bankman-Fried was arrested, Lane said Silvergate had “conducted extensive due diligence on FTX and Alameda Research.” In a later response to the senators, he said the bank was reviewing the transactions in question but didn’t answer specific inquiries, citing confidentiality and bank rules. He hasn’t said anything more. In a conference call with investors last week, Lane declined to answer a question about FTX. (He did say the bank would no longer offer some crypto products and was getting rid of some of its customers — but not because of any “scrutiny” of them.)
The critics aren’t buying Lane’s defenses. Cohodes says that “if Silvergate’s SEN network were operated properly, which it is not, none of this stuff” — meaning those Alameda, North Dimension, and FTX transactions — “would have passed the smell test.” Meanwhile, both Silvergate’s chief anti-money-laundering and sanctions officer and its co-founder have quietly left the bank.
The alleged fraud at FTX has reignited the debate about how much illegal activity goes on in crypto. Crypto defenders have insisted that crime is a small subset of the entire universe. But short sellers, who have pounced on Silvergate, argue that one reason its bank accounts were coveted is that they made room for potential opportunities to skirt the law.
Dollars deposited at Silvergate could move seamlessly among different SEN customers who were buying and selling crypto and then be taken out of the bank. Cohodes says the system is ideal for criminals looking to disguise the origin of money they’re trying to launder: “No one would be the wiser.”
In recent years, banks big and small have been fined billions of dollars for deficiencies in their anti-money-laundering and compliance efforts. In that sense, the controversy swirling around Silvergate is not uncommon in the financial industry. But with U.S. regulators and prosecutors now seemingly pursuing a tougher approach to crypto, the recent crash presents an opportunity to tighten the rules for how crypto companies handle money — and to make it tougher for those funds to enter the traditional banking system.
That regulatory pressure is already showing up in the headlines. A January 3 statement from the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC on the risks posed by crypto appeared to take specific aim at the type of business Silvergate has performed through its internal network: “The agencies have significant safety and soundness concerns with business models that are concentrated in crypto-asset-related activities or have concentrated exposures to the crypto sectors.” They promised to “closely monitor crypto-asset-related exposures of banking organizations.”
“That’s definitely shots fired across the bow” of Silvergate, says David Dorr, the chief investment officer of macro-trading firm Dorr Asset Management.
Silvergate’s clients have also taken note of the regulators’ stance. “The real risk for Silvergate is on the regulatory side,” says BlockTower’s Paul. “No one has any idea how harsh regulators will be.”
As Silvergate’s crypto customers look for alternatives, the New York–based Signature Bank is apparently the “backup” for the industry, Paul says. BlockTower already has an account at Signature, but Paul says his firm is also trying to “onboard” two more banks “as quickly as possible.”
Firms like BlackTower may find that difficult, at least for now. Unlike Silvergate, the much bigger — and profitable — Signature has less of a focus on crypto customers. (Despite being smaller, Silvergate was a pioneer and had more crypto trading volume on its network than that on a similar but newer Signature product.) And though Signature has not been tied to FTX, the bank recently announced it had decided to shrink its crypto business, reporting that its crypto-customer deposits declined by $12 billion last year. The bank is also refusing to handle crypto transactions under $100,000, according to Bloomberg.
“There’s kind of a credit freeze in crypto,” says Paul. “Everyone realized we were lending to one another and trusting counterparties very willy-nilly, and that obviously produced horrible outcomes.” The problem, he admits, is “we don’t really have a better system in place.”