As US banking regulators begin their crackdown on Silicon Valley banks, some experts are pointing the finger at the cryptocurrency market, whose slump in the past year has left tech-focused lenders extremely vulnerable.
The conventional wisdom about cryptocurrency is that it is "self-referential" — a separate universe from regular money — and can contain inherent volatility. A developing "contagion theory" is that there are enough connections for extreme diseases to spread that a virus can sometimes jump from one species to another.
Here's what happened here, according to Bernie Frank, a former US congressman who drafted new banking regulations in the run-up to the 2008 banking crisis and joined cryptocurrency firm Signature Bank as a board member in 2015.
"I don't think this would have happened if it wasn't for the extreme nervousness about FTX and cryptocurrency," Frank told Politico this week. "It was not what regulators might have expected."
Cryptocurrency exchange FTX, which collapsed in November amid widespread fraud allegations, ended a year of turmoil in the cryptocurrency market as investors began pulling funds from more companies. The industry is sensitive to rising interest rates, which have once again exposed a shaky bottom line. In the ensuing "crypto winter," the industry's value fell by two-thirds from a peak of $3 trillion in 2021.
Politicians wanted to reassure the public that volatility in the cryptocurrency market, scams and charlatans who want money out of fear of losing investors will naturally continue. With the fall of SVB, this statement will face its most serious test.
The patient is empty
According to the contagion theory, Patient Zero can be attributed to the collapse of TerraUSD, an "algorithmic stablecoin" that relies on financial engineering to maintain its value against the US dollar. That promise collapsed after a massive sell-off in May last year, causing panic among investors who used the virtual asset as a safe haven to stash money in the cryptocurrency market. The reasons for the crash are still debated, but rising interest rates are often cited as one of the main reasons.
The TerraUSD debacle was a disaster for a major crypto hedge fund called Three Arrows Capital, also known as 3AC. Fund managers have invested $200 million in Luna, a crypto token that once equaled TerraUSD in value, becoming the third largest stablecoin on the market. In late June, a court in the British Virgin Islands ordered 3AC to liquidate its assets.
Lack of funds created additional problems for the industry. Major crypto lending companies such as BlockFi, Celsius Networks and Voyager gave hundreds of millions of dollars to 3AC to fund market rates and have now suffered huge losses.
Customers who had deposited their digital assets with an industry lender were suddenly locked out of their accounts, prompting FTX — the third-largest crypto exchange — to bail out Blockfy and Voyager. Meanwhile, central banks continue to raise interest rates.
The infection was under control for several months until it was revealed in November that FTX was using customers' money for risky bets elsewhere. The exchange was shut down as its customers rushed to withdraw their money from the platform. Meanwhile, Blockify and Voyager are blocked.
The epidemic is growing
This is when an epidemic of risk in the crypto industry could lead to an increase in cash in the banks.
Silvergate Bank and Signature Bank, two small banks that failed last week, had extensive relationships with cryptocurrency exchanges, including FTX. Silvergate tried to reduce its exposure to FTX, but reported a loss of $1 billion in the final three months of 2022 after investors withdrew more than $8 billion in deposits. Signature has also struggled to distance itself from FTX, which accounts for about 0.1% of its deposits.
SVB was not directly related to FTX, but they were not immune to major infectious diseases. Its contributors, including tech startups, crypto firms and venture capitalists, began burning through their cash reserves to run their businesses after venture capital funding dried up.
"SVB and Silvergate had the same balance sheet structure and risks - significant maturity dates, too many realizable uninsured deposits backed by worthless marketable securities and insufficient regulatory capital after unrealized fair value losses were eliminated," says Francis Coppola, former banker and NatWest industry. expert. . . said the POLITICIAN.
Finally, an outflow of deposits has forced SVB to divest offshore assets to satisfy its clients as it struggles to cope with losses on its bond portfolios and foreign interest rates. As rumors spread, withdrawals turned into a bank run as smooth and swift as a crypto bubble.
Zachary Warmbrod and Isabella Kaminska provided coverage from Washington DC and London, respectively.
This article has been updated in accordance with crypto industry standards.