Crypto Receives a Reminder of the Relevance of Banks

The closure of Silicon Valley Bank last week has sparked a period of unprecedented bank turmoil last seen during the Global Financial Crisis (GFC) in 2008.

While 2020 was a nightmare year for most, it was a boom for the tech sector. People were spending more time on their phones and computers, conferencing software came into its own, and new money and a hiring spree meant the sector was more vibrant than almost any other part of the economy. 

Silicon Valley Bank (SVB), one of the leading banks in the technology sector, had $60 billion in customer deposits in the first quarter of 2020 and $200 billion by the first quarter of 2022. The good times weren’t to last.

Silicon Valley Bank Is the Largest Failure of a Bank Since 2008 

However, the bank invested in treasury bonds and mortgage-backed securities but suffered grave losses when the Federal Reserve raised interest rates to combat rising inflation. Silicon Valley Bank sold assets to minimize losses. But when it announced it needed to raise $2.25 billion in capital, clients withdrew $42 billion in deposits. Regulators shut down the bank the following day. It’s the largest failure of a U.S. bank since the GFC in 2008. 

However, on Sunday, the U.S. government announced depositors would be able to access their cash from Monday. All depositors would be fully protected, assuaging fears of a wider crisis. The U.S. Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) have stated that the taxpayer will not bear any losses from the move.

Meanwhile, an offer has been made for SVB’s U.K. arm, with a consortium of investors led by the Bank of London submitting a formal bid to the U.K. Treasury. The British government has been working on a plan to support U.K. tech firms affected by the collapse of SVB.

While Silicon Valley Bank was not as exposed to crypto as Silverware, it has already caused ruptures across the industry.

USDC Depegged Following Silicon Valley Bank Collapse

The stablecoin USD Coin (USDC) declined to a low of $0.879 on CoinMarketCap. Circle, the company behind USDC, had $3.3 billion of exposure to SVB, causing concern among investors that the stablecoin may not maintain its peg to the U.S. dollar. Although the $3.3 billion only makes up $40 billion of total USDC reserves.

“Silicon Valley Bank… has just suffered a classic bank run, much like those we saw during the financial crisis in 2008,” the company said in a blog post on Saturday. “$3.3bn of USDC’s cash reserves remain with SVB. As of Thursday, we had initiated transfers of these funds to other banking partners. Though these transfers had not yet been settled as of close of business Friday, we remain confident in the FDIC’s management of the SVB situation and stand ready to receive these funds.”

Why does a bank collapse affect the peg of a stablecoin? In part because USDC is fully reserved-backed. That means every USDC is backed by actual cash and short-dated United States treasuries. If part of that reserve disappears or goes missing—even temporarily—the market will lose confidence. Investors will worry whether the stablecoin can retain its value.

And then there’s Silvergate, whose collapse took place only days before the SVB turmoil.

Crypto-Friendly Banks Had a Nightmare Week

The bank, which had high-profile clients such as Coinbase, Gemini, Paxos, and Circle, blamed the collapse of Sam Bankman-Fried’s FTX exchange empire for its woes. The bank’s shares dropped 20% after the Justice Department announced an investigation into its role in the collapse of FTX.

Silvergate’s collapse has left a hole in the U.S. cryptocurrency industry, with many crypto exchanges struggling to move dollars into their trading accounts and off-ramp them into their bank accounts. Companies like Coinbase, Crypto.com, and Paxos quickly distanced themselves from the bank. 

Unfortunately for crypto, Silvergate’s implosion will likely draw more scrutiny from lawmakers. There is growing concern about the impact of the industry on traditional finance.

“As the impact of FTX’s collapse continues to ripple outward, today we are seeing what can happen when a bank is overreliant on a risky, volatile sector like cryptocurrencies,” said Sherrod Brown, a progressive U.S. Senator, and Chair of the Senate Banking, Housing, and Urban Affairs Committee.

“I’ve been concerned that when banks get involved with crypto, it spreads risk across the financial system, and it will be taxpayers and consumers who pay the price.”

After Silvergate announced its voluntary liquidation, blockchain companies turned to Signature Bank. One of the last banks in the U.S. to offer financial services to the volatile industry. However, two days after the Silicon Valley Bank collapsed, the New York Department of Financial Services took possession of Signature Bank, which has deposits totaling $88.59 billion.

For crypto companies partnering with Signature, the announcement brings immediate relief that their deposits will be protected. But it leaves the open question of where they will find banking services.

What About the Bankless Future?

So what about the financial-tech utopia that crypto promised? Why has the collapse of two banks sent the crypto markets into a tailspin? Wasn’t crypto supposed to supplant the traditional financial system?

It was, or it still may do. That all depends on who you ask. However, the cruel fact is crypto still exists in a wider financial system, of which traditional banks are a big part. And even if your crypto principles mean you want to avoid interacting with banks as much as possible, the people who invest in your company, those who trade your token, and the other businesses you work with, will have different ideas.

The “bankless” future many envisioned has almost come true this week. Although not quite how people imagined.

Of course, traditional retail banking will be a must until you can pay for more goods and services in cryptocurrency.

Unfortunately for the crypto maximalists, traditional-style banks are the axles on which the wheel of the financial system spins. When they go down, crypto is inevitably affected.

Also, DeFi simply isn’t mature enough to replace banks yet entirely. The total DeFi market cap is less than 50 billion dollars. Whereas the traditional financial industry is measured in trillions of dollars. Until that reality changes, the crypto industry will need to be mindful of the importance of these financial behemoths.