Since the inception of Bitcoin, the adoption of cryptocurrencies has soared, with their market value ballooning to an impressive $2.7 trillion. In 2024, over a dozen world governments hold Bitcoin, and several major multinational conglomerates have incorporated cryptocurrencies into their balance sheets.
Banks too have not lagged behind; they began onboarding, supporting, and even investing in crypto, lending an air of legitimacy to the sector and reassuring other investors about its credibility. However, in March 2023, many of these banks encountered significant difficulties with some eventually collapsing.
It is crucial to understand that their downfall was not due to their involvement in blockchain and cryptocurrencies. This article explores the history, causes, and lessons learned from the 2023 banking crisis.
The Crypto Boom and Its Effects
From a single cryptocurrency—Bitcoin—the industry has rapidly expanded. Fifteen years later, there are now over 20,000 different crypto assets, each with a unique purpose. The creation of such diverse cryptocurrencies has significantly contributed to retaining liquidity within the crypto space.
The rising value of Bitcoin, driven by its scarcity and increasing demand, has prompted many skeptics to reconsider their positions. Crypto exchanges and DeFi protocols have demonstrated that on-chain companies can hold billions of dollars relatively safely, attracting the interest of traditional banking institutions.
For instance, centralized exchanges like Binance are currently processing over $19 billion daily and holding more than $28 billion in customer funds. These figures are particularly impressive compared to traditional banks, which operate under stringent regulatory protocols. The allure of serving the lucrative crypto market proved irresistible for banks, leading some to eventually venture into the blockchain space.
Case Studies: Banks That Fell
1. Silicon Valley Bank
Silicon Valley Bank (SVB), a division of First Citizens Banks, had been operating for 40 years before calamity struck. The bank openly supported cryptocurrencies and even had a whole page on its website for it. According to the still present webpage, Silicon Valley Bank supports “the vision of venture-backed, blockchain-based companies”. The bank had arms in crypto exchanges, DeFi, mining, and even non-fungible tokens (NFTs).
SVB’s problems did not begin in March 2023 but had been progressively growing as the bank became over-exposed in long-dated government bonds. When withdrawals increased, SV could not deliver, leading to a collapse.
The bank also faced regulatory issues since their investments were not FDIC insured and hence their losses could not be recovered. Finally, on March 10, 2023, the California Department of Financial Protection and Innovation (CDFPI) closed SVB.
SVB’s crash, although not caused by crypto volatility, had a significant impact on the stablecoin markets. USDC, the second-largest stablecoin, had 8% of its reserves—around $3.3 billion—held at the bank.
This revelation led to USDC de-pegging from the U.S. dollar, dropping to below $0.88 as panic gripped the crypto market. The ensuing sell-off triggered massive liquidations across various cryptocurrencies and a significant decline in the overall crypto market capitalization. Despite the turmoil, Silicon Valley Bank continues to operate, striving to recover and emerge stronger.
2. Silvergate Bank
Silvergate Bank positioned itself as the premier bank for both business and cryptocurrency in San Diego. Among the banks affected by the financial turmoil, Silvergate arguably suffered the most significant blow, as it has yet to recover. A report by the Congressional Research Service (CRS), titled “The Role of Cryptocurrency in the Failures of Silvergate, Silicon Valley, and Signature Banks,” highlighted Silvergate as one of the institutions that provided services to cryptocurrency firms, including holding their deposits and lending them funds.
In addition, Silvergate operated its own blockchain called the Silvergate Exchange Network (SEN), launched in 2017. According to the International Banker, this network facilitated trillions of dollars in transactions among crypto-trading institutions.
Silvergate had the highest concentration of deposits in the crypto industry, with over 90% of its deposits coming from crypto clients. The challenges that led to Silvergate’s downfall were mainly due to inadequate risk management. The primary issue was its overexposure to volatile short-term deposits while engaging in long-term lending or investing. Ultimately, Silvergate was caught in a bank run and collapsed. As part of its wind-down plan, the bank committed to fully repaying all customer deposits.
Silvergate’s collapse was perhaps the most devastating for the crypto industry due to its heavy reliance on deposits from crypto clients. The unraveling of Silvergate prompted the U.S. Department of Justice to investigate the bank’s dealings with FTX, a company that had been involved in a years-long scheme to defraud investors. Although the investigations yielded no concrete results, the alleged connection to FTX alarmed and unsettled crypto investors.
3. Signature Bank
Signature Bank, the 29th largest bank in the U.S., was headquartered in New York and offered services to both traditional and crypto-based clients. As part of its corporate vision, Signature aimed to unlock limitless possibilities through “leveraging technology.” According to the International Banker, Signature Bank developed its own blockchain network called Signature Signet in 2019. The Congressional Research Service (CRS) reports that 20% of the bank’s deposits consisted of digital asset reserves.
Signature Bank’s failure resulted from a precautionary measure taken by federal regulators. According to Investopedia, on March 12, 2023, federal regulators issued a directive to shut down Signature Bank amid concerns that the contagion from SVB’s collapse could spread to the bank. Regulators had already observed a pattern of large-scale withdrawals by depositors attempting to avoid potential losses.
Signature Bank secured its place as the third-largest bank failure in U.S. history. According to CNBC, the bank remained unaware of any major issues until a sudden run on deposits late Friday. Finally, on March 12, 2023, the New York Department of Financial Services (NYDFS) closed Signature Bank and appointed the FDIC as the receiver.
The financial institution was among the few banks that had welcomed crypto deposits since 2018, and its collapse had an impact on the crypto markets, although not as pronounced as Silvergate’s. On March 20, 2023, New York Community Bancorp (NYCB) agreed to acquire $38.3 billion of Signature Bank. The remaining $60 billion was placed under the receivership of the Federal Deposit Insurance Corporation (FDIC).
4. Farmington State Bank
Farmington State Bank, a small bank located in Eastern Washington, became deeply entangled in the collapse of FTX. Marketed as an independent, locally owned community bank, it ultimately folded in 2023, although its troubles had begun much earlier. In January 2023, The Spokesman-Review reported that federal prosecutors seized $40 million from Farmington State Bank amid allegations of its involvement in the FTX fraud scheme.
Reports from the Fed investigation indicate that Sam Bankman-Fried, often referred to as SBF, deposited several million dollars into the small bank. The trouble began when $50 million was seized from an account under the name ‘FTX Digital Markets,’ exacerbating the bank’s difficulties.
In July 2023, federal regulators issued a cease and desist order against the small bank due to its association with FTX. Attorney John Deaton has recently commented on the Farmington State Bank, which was later found to be linked to SBF.
Deaton asserted that the entire case reeked of corruption, questioning how a single individual could acquire a small bank and promptly gain access to the Federal Reserve Banking (FRB) system. He highlighted the hypocrisy of figures like Elizabeth Warren, citing evidence of bribery that surfaced during SBF’s trial.
On February 6, 2024, federal regulators concluded their enforcement action against Farmington State Bank and its holding company, FBH Corporation. Farmington State Bank has ceased its operations as a bank.
Lessons for the Future
The collapse of these institutions raises significant concerns about risk management within the banking sector. Most of these banks failed because of inadequate risk management practices and excessive exposure to volatile assets. Moreover, achieving a balance between innovation and prudence is crucial for the success of any financial institution. The failure to comply with regulatory standards also plays a significant role in the downfall of banks, especially when they encounter mass withdrawals.
Signature Bank, lacking FDIC insurance, never managed to recover from its collapse. In contrast, Silvergate and SVB, which were insured, ensured that depositors received full refunds of their deposits. Despite their support for crypto, the crash was not caused by their investments in cryptocurrencies. Instead, the primary issue stemmed from their failure to diversify beyond long-term government bonds.
Conclusion
The rise and fall of these crypto-affiliated banks highlight renewed concerns over the limited banking options available to crypto firms. While the SEC closely monitors crypto entities, there is currently no regulation explicitly prohibiting financial institutions from providing banking services to them. By 2024, the crypto-banking landscape has undergone significant changes, with banks like JP Morgan Chase developing their own blockchain networks for efficient cross-border payments. Hedge funds such as Blackrock and Fidelity have emerged as major buyers of Bitcoin, signaling a rush by traditional finance to embrace crypto. This shift suggests that crypto integration may not be detrimental to banks, provided it is approached correctly.