What does Silvergate's shutdown mean for the crypto industry?

Cryptocurrency-friendly lender Silvergate Capital (NYSE:SI) is crumbling and that is “definitely not good for the crypto industry,” said Konstantin Shulga, CEO and co-founder of institutional crypto liquidity marketplace Finery Markets.

Silvergate (SI), the bank that had ties to Sam Bankman-Fried’s failed crypto exchange FTX (FTT-USD), has become the latest victim of the lingering market downturn, after revealing plans to wind down operations and voluntarily liquidate.

Before that decision, the 35-year-old San Diego, California-based company, which posted $1B of losses in Q4, said about two weeks ago it was forced to assess its ability to continue as a going concern, spurring an exodus among its institutional clients, including Coinbase Global (COIN) and Galaxy Digital (OTCPK:BRPHF). Silvergate (SI) then said it would discontinue the Silvergate Exchange Network, its crypto-payments platform, which was rolled out in 2018 to enable instant, 24/7 transfers between market participants and crypto exchanges and quickly grew to be one of its main growth drivers.

What was once a $200 stock in late 2021 – the same year when bitcoin (BTC-USD) reached all-time highs – is now less than $3, as Silvergate (SI) saw its customers rushing to withdraw money out of the bank after November’s collapse of FTX (FTT-USD) and its sister trading firm Alameda Research, both of which reportedly had accounts at Silvergate. The Department of Justice last month was said to have started probing Silvergate’s relationship with Bankman-Fried’s crypto empire.

Things could have been even worse if it did not hold $4.3B of short-term advances from the Federal Home Loan Bank at the end of 2022, in addition to the roughly $4.6B it had in cash. In starting the process of phasing out its bank operations, "It's difficult to know what the ultimate outcome and timeline of this process will be," KBW analyst Michael Perito wrote in a note to clients last week.

Prior to its demise, Silvergate (SI) was a key player in providing crypto-related banking services, but the financial contagion effects from the FTX (FTX-USD) downfall tarnished its once-mighty reputation.

“The Silvergate case is special as the bank lost money not by making risky overleveraged loans against crypto collateral (like in the case of 3AC, Celsius, or FTX collapse), but by doing regular banking,” Shulga told ICS-digital in a recent interview, referring to the additional securities it sold at a loss so far in 2023 to fund the outsized run on deposits.

In turn, “a downward spiral ensued with rapidly worsening capital adequacy ratios, which led to more clients withdrawing funds,” he added. “It’s definitely not good for the crypto industry, and this could potentially mean a certain trend towards crypto moving outside the U.S., at least until a more comprehensive regulatory framework is established in the U.S. Increased clarity on rules and regulations will actually increase the number and quality of banking relationships for crypto firms, as the industry stays here no matter what happens to Silvergate.”

While Seeking Alpha contributor The Digital Trend expects "drastic" effects in the crypto space from Silvergate's (SI) fall, "we know how resilient the crypto space and community are, there will be a rise from the ashes, and alternative payment 'rails' will be sought."