#54 The banking system tests crypto's resilience
The third and fourth biggest bank shutdowns happened last week, in what appears to be either an emerging banking crisis or a covert operation against crypto. Or maybe both.
One does not simply plan a crypto newsletter. Crypto decides what you write about. This was going to be a week about building a better UX for crypto when we suddenly witnessed our umpteenth existential crisis falling upon us. It all started gradually, with Jerome Powell delivering hawkish remarks in the US Congress, and blew up with the contagion effect that ensued after the collapse of Silicon Valley Bank.
By now, you are probably well aware of the chain of events that has dragged crypto through the mud this weekend. If you’re not, a few articles explain the events well (Bloomberg, Coindesk….). In a minute, we will give you a quick overview, but today we want to focus on how the industry is in the middle of a new spiritual struggle, which this time has to do with a bad breakup with banks.
Earlier last week, Silvergate, “crypto’s BFF bank,” announced an orderly liquidation process after assuming they couldn’t resume business as usual. However, long-time crypto enemies like Elizabeth Warren pointed out that the bank had collapsed because of its exposure to the shady ways of crypto.
Before the weekend started, though, Silicon Valley Bank tanked too, in the second biggest bank shutdown since Washington Mutual in 2008. But this time, it was not all crypto’s fault. SVB failed to prepare for a high-interest rate situation. Since interest rates have risen quickly, the value of the Treasury bonds they bought in a low-interest context has dropped significantly. This means that in the case of a sudden rush of people trying to withdraw their money from the bank, the bank may need to sell the bonds at a loss to generate enough cash to meet the demands of its customers. And that might not even be enough.
After SVB came Signature bank, the other crypto-friendly bank, also suffocated allegedly by a massive bank run. In both cases, the FDIC (Federal Deposit Insurance Corporation) had to intervene to ensure that depositors were made whole after the crash.
This leaves us with a need for a profound moment of introspection in crypto. But, this is what we were in for an alternative financial system, independent from the regular banking pipelines, because of the lack of trust in their constant collusion with partisan politics. This is where crypto dug its roots.
We don’t speak enough about Elon Musk’s ability to express the zeitgeist in memes.
After the initial moments of panic, crypto seems to be recovering. Zooming out to the last 30 days, the BTC price appears to have been down the valley of doubt and then out. The reasons are a combination of a swift reaction from the authorities; this is probably just a manifestation of the current state of instability. Still, in the long run, it makes sense that crypto survives this crisis too.
Contrary to what Liz Warren thinks, the problem is not crypto. It is TradFi’s sin. Crypto was born to offer an alternative to some of the issues we’re witnessing today. Using it as a scapegoat is a myopic view. The US is not strangling crypto; it’s pushing it away. Crypto was designed to survive in the worst banking conditions. It’s like a Gremlin tardigrade: it can endure extreme pressures, radiation, and even the lack of oxygen. But if you feed it after midnight or make it wet, it will multiply. And many other countries are armed with food and water, ready to welcome the new creature. The US could be bullying one of the best future use cases for US Dollars.
Let’s go through all the events that led us to this point.
We asked Dall-E for a combination of Gremlin and tardigrade, but the results were awful, so we’ll let this unique creature represent crypto this week.
⬡ Six Angles
We select six topics to illustrate the different angles from which we can approach crypto. We could choose dozens, but six is the atomic number of carbon… and otherwise, we’d be writing for ages.
1. Interest Rates | Hawikish Jerome Powell is back
Earlier in the week, US Fed chairman Jerome Powell had a few words about crypto (We Don’t Want to Strangle Crypto Innovation, but Sector Is a Mess) and some more words about interest rates, which is more his jam. Speaking in front of the House Financial Services Committee, he made hawkish remarks that made traders feel more certain about a 50bp hike in a couple of weeks.
This is actually a potential choke point in and of itself:
Interest rate hikes damage a bank’s balance sheet if it has failed to hedge its risks (which seems to have been the case at SVB).
It can also push liquidity away from bank deposits and into the hands of the government through Treasury bonds. Some have pointed at this as bank-run fuel and a possible starting point for the advent of CBDCs.
2. Bitcoin | The ghosts of Mt. Gox and Silk Road
During this fateful week, BTC holders were also visited by ghosts of the past. The Mt. Gox settlement case threatened to dump billions of dollars in bitcoin into the market during a less-than-ideal moment.
In 2014, Mt.Gox lost 850K BTC of their customer funds. Today, 140k BTC has recovered (around $4B), and some will soon return to their owners. BTC in 2014 peaked at ~$900 in January and saw lows of ~$300. Mt. Gox victims have potential earnings a couple of order magnitudes higher than their original investment, so a liquidation event is not unlikely.
At the same time, the US Department of Justice was doing precisely that: moving $1B in seized bitcoin from the infamous Silk Road marketplace.
At some point during the week, it seemed like this would affect the investors’ perspective on BTC.
3. Ethereum | NYAG casually calls Ethereum a security
In a lawsuit against the exchange KuCoin, the New York Attorney General called Ethereum a “speculative security.” It is becoming a tradition to use court rulings about tangential issues to tell the world whether a cryptocurrency is a security or a commodity, disregarding any other public or private debate.
ETH went down, and we hadn’t even started with the banking drama yet.
4. Banking crisis | Silvergate falls in style
First, they delayed their reporting obligations, then they wound down operations, then they closed their flagship token transfer service, and finally, they announced the voluntary liquidation process. As a result, Silvergate will close its gates, but only after fully repaying all its deposits.
This graceful exit is not what we’re used to in crypto, and still, Elizabeth Warren and Company are trying to use this case as a cautionary tale against the risks of crypto.
5. Banking crisis | The aftermath of SVB
When the FDIC takes over a bank, deposits of $250k or less are guaranteed by regulators. In a bank that catered to Silicon Valley startups, VCs, and other tech giants, it seems like just a small portion of customers fit that category (estimations say 89% of funds are “uninsured”).
Among those customers whose funds have entered regulatory limbo was Circle: the conglomerate in charge of USDC, the second most important stablecoin. During the stressful quiet hours of the weekend, Circle failed to provide clear and transparent information about their exposure to SVB. It was a “modest” $3,3B deposit that could probably be retrieved safely once operations restarted. But while fear dissipated, USDC depegged from the dollar (down to minimums of $0,87), unleashing panic. Any project exposed to USDC suffered: the list is massive (starting with other stablecoins like DAI).
The fear seems to have dissipated already, and, as always, it will take time until the dust settles and we see the magnitude of the damage. Nevertheless, the crisis might have been averted from a short-term financial perspective. Things seem reasonably SAFU, but there’s a widespread feeling that we will see more banks fall.
Within the walls of crypto, investors will likely take a firm stance about what happened. And lately, after every crisis, the community has renewed its vows of decentralization.
6. Banking crisis | The unexpected fall of Signature Bank
When Silvergate’s customers left the bank, many landed in Signature’s banks. Signature became the next go-to financial institution for crypto companies, maybe reluctantly, since the company was proactively limiting its crypto exposure (in January, they halted SWIFT operations with Binance for less than $100k).
Then the weekend banking kerfuffle happened, and Signature was seized by the FDIC, too, while all eyes were on Silvergate.
There’s some evidence that Signature’s fall might be part of a deliberate effort from US regulators to cut off crypto from banking. You can read some in Nic Carter’s Twitter, the article's author, Operation Choke Point 2, the post that revealed the theory that the Biden administration is sponsoring the current situation.