A Tale of Two Bank Runs Shows Crypto Isn't the Enemy

It's not every day that lightning strikes twice

All hell is breaking loose in the banking world.

Ok, maybe not anywhere near the scale of 2008, but certainly the most exciting week in the banking world in a few years. And since this is a crypto-focused investing newsletter, let me take the opportunity to highlight why crypto is both not to blame — and, very possibly — somewhat to blame.

As we highlighted last week, one of crypto’s go-to banks died. Silvergate, one of the most robust banks to offer crypto companies a regulated option for deposits, announced Wednesday that it would be shutting down and returning deposits to customers after suffering an overwhelming wave of companies taking their money back.

Predictably, politicians like Sen. Elizabeth Warren and Sen. Sherrod Brown wasted absolutely zero time dancing on crypto’s grave — claiming they saw all of this coming and that crypto was to blame.

But now, Silicon Valley Bank, one of the nation’s largest banks (in the top 20 by deposits) is suffering from almost exactly the same issue that took Silvergate down. And not to trigger any panic — but Silicon Valley Bank is 20-times as large as Silvergate was. On Thursday, Silicon Valley Bank’s stock crated 60% after warning investors it was raising more cash to stem the problem. But what is the problem?

As Bloomber’s Matt Levine recently highlighted, the problem isn’t anything unique. Banks take in cash deposits and try to make money on those deposits. Usually, that means taking a portion of those deposits and “lending long” by buying long-dated mortgage-backed securities, or bonds. And that is usually extremely safe! Except for when a bunch of your depositors request cash at the same time. Because then you’re forced to sell things, and often at a loss.

Silvergate’s depositors really vanished, and it is shutting down; Silicon Valley’s story is more “a slowdown in VC funding” and “cash burn at many of its clients.” There is still a lot of franchise value there, which is why it can plug the hole in its balance sheet by selling stock instead of by shutting down.

- Matt Levine

Silvergate’s problem was that almost all of their customers were crypto companies. Silicon Valley Bank’s problem is that almost all of its customers are tech startups. For the former, a crypto collapse triggered a run. For the latter, the spark is a little less clear — but it might come to light that the two might be related.

The reason I say that is because I suspect more than just a few fintech startups had been secretly dabbling in crypto. At least one — a Peter Thiel-backed lending startup named Eco — was recently exposed for doing just that. The company promised juiced interest rates for savers by secretly parking customer deposits in crypto lenders like BlockFi and decentralized finance applications. They sucked in cash by promising 5% interest in some cases rather than the 2.5% that was the going rate. So they very likely could have been caught in the Silvergate run and then spilled over to cause some drama at Silicon Valley Bank.

But, Silicon Valley Bank is huge. Even if it were true that a couple of companies were lying about not being involved with crypto, that wouldn’t be enough to cause a run on SVB. So what else is going on? Well …

The bank’s niche of serving venture capital-backed US tech and life sciences companies has helped it enjoy massive growth in recent years as money poured into Silicon Valley start-ups in an era of low interest rates. ...

However, the bank is now suffering from a slowdown in VC funding, a cash burn at many of its clients and losses on investments it made when rates were at rock-bottom levels.

During the recent tech boom years, SVB’s deposits swelled as it took on cash from start-ups flush with VC funding. SVB ploughed much of these deposits into long-dated securities like US Treasuries, which are deemed safe but are now worth less than when the bank purchased them because the Federal Reserve has increased rates.

It will be interesting to see how politicians and regulators try to backpedal on this one. Clearly the lesson here is less “don’t bank crypto” and maybe more “don’t concentrate all your depositors in just one industry” (i.e.: just crypto companies, or just startups.) And furthermore, it will be interesting to see if SVB can avoid the same fate as Silvergate. Late Thursday Peter Thiel told Founders Fund portfolio companies to withdraw funds from SVB. And as we know, bank runs can become self-fulfilling.