Banking Crisis Survival Guide (Preview)
Bank failures around the United States are a concerning trend for anyone who holds their money at select banks. We look at events leading up to the banking contagion and how bitcoin fixes this.
Relevant Past Articles:
The Contagion Continues: Major Crypto Lender Genesis Is Next On The Chopping Block
Silvergate Bank Faces Run On Deposits As Stock Price Tumbles
The Crypto Contagion Intensifies: Who Else Is Swimming Naked?
This is a preview of the “Banking Crisis Survival Guide”. The full in-depth report has been released to paid-tier Bitcoin Magazine PRO subscribers. If you would like to view the report in full, upgrade your subscription today.
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Introduction
The last few weeks have been a worrying time for anyone who holds their money at select banks. Silicon Valley Bank (SVB) experienced the second-largest bank collapse in U.S. history, with $209 billion dollars in assets at the time of its failure. This is second only to Washington Mutual, with $307 billion in assets as it fell in 2008.
For the first time in decades, many are considering whether or not their deposits are verifiably safe in financial institutions. Many regional banks are experiencing significant financial distress in the aftermath of Silvergate and SVB. Wary depositors have begun to move their funds to larger, national banks colloquially recognized as “too big to fail.”
Banking is a confidence game after all, and that confidence is starting to wane everywhere you look. There is a distinction however between the Great Financial Crisis in 2008, and what we’re seeing play out over the last couple weeks. Today, it’s not about extreme credit risk in the system, excessive bank leverage and subsequent wave of defaults, but more about the duration risk of bank assets and liquidity. The rapid pace of interest rates rising have exposed those who haven’t managed that risk.
During this chaotic period, bitcoin — traditionally viewed as a risk-on asset — has seen exceptional appreciation, rising approximately 20% after SVB’s collapse. While this is not new for the volatile currency, it surprised many to see such resilient performance amid widespread anxiety from market participants. Although it’s exciting to see bitcoin moves like this short-term, it must sustain to act as a real safe-haven bid. Bear markets are known for their explosive volatility moves in an increasingly illiquid bitcoin market.
In this report, we unpack the cause of the banking crisis, the portfolio mismanagement of the failed banks and the role that monetary policy and the Federal Reserve has played in this context. We will also highlight issues with so-called stablecoins, and the ways in which bitcoin solves many of the issues of the modern-day banking system.
All things considered, these events serve as a stark reminder of the risks inherent to fractional reserve banking and highlight the use case of bitcoin, an asset with zero counterparty risk that exists as the liability of no third party.
Contagion Recap
To start, it’s important to set the stage for what Bitcoin has experienced over the past year — chief among these events is the significant contagion unwind experienced in the broader crypto landscape. Unsurprisingly, contagion is pervasive in the cryptocurrency industry. We’ve been beating this drum since the fall of Celsius and Three Arrows Capital (3AC) in May 2022. What is more surprising to some observers of traditional financial markets is just how deep the contamination goes.
Bitcoin was created in part to eliminate third-party risk through peer-to-peer exchange of electronic cash. Time and time again, we have witnessed the essential vision of Bitcoin be distorted through intermediaries and the ensuing counterparty risk.
One of the more notable examples of the dangers of trusting third parties in Bitcoin’s history was the fall of the Mt. Gox bitcoin exchange in early 2014, when the company halted withdrawals and announced a loss of almost 750,000 of its customers’ bitcoin plus around 100,000 bitcoin of its own — about 4% of the total bitcoin supply, worth close to $473 million at the time of the bankruptcy filing. The Mt. Gox failure was due to a hack and subsequent draining of the company’s reserves.
These types of counterparty risks are exactly what Bitcoin was designed to avoid, but bitcoin needs to be held in self-custody in order for it to be safe from third-party malfeasance. Even after the notorious collapse of Mt. Gox, there were numerous other examples of exchanges running off with customer assets.
More recently, bitcoin that was not wholly owned by exchanges or created out of thin air — “paper bitcoin” — became popular as firms leveraged their customers’ bitcoin by lending it out while offering “yield.” We warned about some of the issues with yield services in May of last year.
These issues first came to light when the Terra stablecoin (UST) lost its peg, causing those with exposure to the Anchor protocol — which was offering as much as 110% APY on UST deposits — to face incredible losses. Little did we know at the time that we would spend the next few months covering the widespread contagion that permeated the larger cryptocurrency industry.
Shortly after the fall of Terra/LUNA, the Celsius exchange and lending platform halted withdrawals. On June 13, 2022, we took a closer look at this particular case in “Celsius Exchange Halts Withdrawals: What Went Wrong?”
“As of late, novel narratives have been employed to drive retail customers to believe in the power of ‘blockchain technology’ and ‘cryptocurrency’ as drivers for a revamped financial system. However, as argued before, blockchain serves a very specific purpose: to solve the double spending problem to port cash (peer-to-peer money) into the digital realm. This was achieved by Satoshi Nakamoto, who, after decades of research by many scientists and mathematicians, arrived at the design of Bitcoin — published in a proper white paper in 2008.”
Peer-to-peer money and the elimination of double spending and counterparty risk were always Bitcoin’s goals. After the fall of Celsius, it was more apparent that there would continue to be tail risks associated with the interconnected crypto industry and we once again warned that investors should exercise caution and expect more cards to fall.
While there were many further bankruptcies immediately after the collapse of LUNA, Celsius and 3AC — Voyager, BlockFi, Finblox, Derebit, Babel, Maple Finance and Coinflex — major exchange FTX came to the rescue with the offer for large bailouts for many of these companies.
We covered these events in great detail in our Contagion Report.
What became apparent later that year was that FTX did not actually have the capital to help these firms, and was largely impacted by the 3AC blowup along with the same firms it swooped in to save. On November 10, 2022 — the day before FTX filed for bankruptcy — we wrote “Counterparty Risk Happens Fast” to warn readers:
“This is a Long-Term Capital Management and Lehman Brothers-style moment, and is potentially larger in magnitude than what happened with the previous market contagion. There will be more names and bodies to surface in the aftermath. All eyes are now on the counterparties of Alameda, all other exchanges in the space, stablecoin operators and highly connected companies in the ecosystem: Genesis, Silvergate, Galaxy Digital, CoinShares and BlockFi are a few examples.
“We don’t intend to fuel any additional FUD (fear, uncertainty and doubt) on the fire, but once again, the contagion will spread and there will be second- and third-order effects to play out. For Silvergate, FTX was their largest customer; they announced a change in executive management just a few days ago, the stock is down over 31% in just five days and are in the midst of bleeding customer deposits. Even worse, they issued a statement highlighting that ‘they have the ability to borrow from the Federal Home Loan Bank to strengthen liquidity.’”
The destruction of FTX was swift and complete. We covered these events in The FTX Ponzi special report, so we won’t rehash them here.
One of the unanswered questions after the failure of FTX was what other institutions were severely affected. Just a week following the bankruptcy filing, we questioned how Silvergate Bank would fare.
“Who else is at the center of many institutions in the market? Silvergate Bank is one of those. Since the beginning of November, their stock is down nearly 56%. Silvergate Bank is at the nexus of banking services for the entire industry, servicing 1,677 digital asset customers with $9.8 billion in digital asset deposits…
“Even if a bank run scenario is unlikely, Silvergate deposits are likely to take a hit and we’ve yet to see second-order effects take shape from that happening. Signature Bank is the other main banking provider for the industry…” — The Contagion Continues: Major Crypto Lender Genesis Is Next On The Chopping Block
Though we didn’t think a bank run was likely at the time, this was before rumors of the U.S. government discreetly forcing banks to cut ties with the crypto industry. In January, Silvergate saw a run on its deposits.
“As details emerged regarding the Silvergate operation, specifically in regards to the relationship with FTX — the fact that deposits to FTX were routed to the Alameda Research bank account at Silvergate — some investors began worrying about impending regulatory clampdown due to seemingly lax compliance and the possibility of anti-money laundering violations. As a result of this concern, the share price of Silvergate started to aggressively slide. Since the collapse of FTX, shares have fallen by nearly 80%.
“The worry for Silvergate following the collapse of FTX was unlike many of the crypto-native firms that went bust over the course of 2022. Some of the issues we saw that led to other blowups were sour crypto-native loan books and large directional exposure to faltering crypto assets. As a traditional fractional reserve bank, the largest worry for SIlvergate was having a run on its deposits, which is exactly what happened when Silvergate announced its quarterly report, leading to shares plunging by more than 40% in a single trading day.” — Silvergate Bank Faces Run On Deposits As Stock Price Tumbles
Then on March 3, Silvergate announced that it was closing the doors on its proprietary Silvergate Exchange Network (SEN). We explained the duration mismatch with the company’s long-term bonds and its depositors demanding their money back.
“As a traditional fractional reserve bank, Silvergate took client deposits — which drastically increased in 2021 — and lent them out over a long duration, into U.S. Treasury bonds, in particular. In practice, firms would lend their money to Silvergate by depositing at 0% in order to utilize their Silvergate Exchange Network (SEN), and Silvergate would then lend out those same dollars at a higher interest rate over a long period of time. This is a great business model — as long as your loans don’t fall in value at the same time as clients go to withdraw their funds.”
“A majority of Silvergate’s deposits came during a world of zero-interest-rate policy, where short-duration Treasury securities offered 0% yield. This phenomenon is one of the core reasons why Silvergate invested in longer-duration instruments. The bonds fell in value as global interest rates rose throughout 2022.
“With long-duration debt securities, money isn’t lost in the case of rising interest rates as long as the bond is held to maturity (and not defaulted upon), but in the case of Silvergate, fleeing deposits forced the firm to realize the unrealized losses on their securities portfolio — a nightmare for a fractionally reserved institution.” — Banking Troubles Brewing In Crypto-Land
Silvergate’s collapse may have been a disastrous turning point for public trust of banking institutions and its liquidation preceded the events of the last week by demonstrating the harsh truth of our current financial system: the funds in your bank account may not be as liquid as you once thought.
This concludes the preview of our full report on the current Banking Crisis which has been released to paid-tier Bitcoin Magazine PRO subscribers. If you would like to view the article in full, upgrade your subscription now! Get 25% off an annual subscription below!