Crypto industry unbanked, financial system at risk, and light at the end of the tunnel for the crypto industry

1. From stablecoin issues to an unbanked crypto industry in a weekend

The Facts:

• Following Silvergate’s voluntary closing down last Wednesday, see prior coverage, just two days later Silicon Valley Bank (SVB) collapsed and has consequently been taken over by the Federal Deposit Insurance Corporation (FDIC), and on Sunday, crypto bank Signature was seized by the New York State Department of Financial Services (NYDFS).
• An essential infrastructure by Silvergate and Signature were their respective SEN and SigNet networks, which allowed real-time 24/7 transactions amongst partner banks.
• The SVB has been servicing more than 50% of all start-ups in Silicon Valley, while also being the venture capital (VC) bank for the crypto industry, holding the funds of major renowned crypto hedge funds and investment funds, including Andreessen Horowitz or Sequoia Capital.
• Over the course of a mere five days most of the U.S. based crypto industry has been unbanked consequently, amidst stablecoin depegs and fear within the crypto industry.
• Bitcoin Suisse has no direct exposure to either Silicon Valley Bank, Signature and Silvergate, or any other US-based bank. We are working with a group of banking partners domiciled in Switzerland and Liechtenstein for fiat payments and settlements. Our banking partners confirmed their ability to process USD payments.

Our Take:

• Losing Silvergate and Signature Bank, the two banks that serviced the majority of the crypto industry as on- and off-ramp liquidity service and crypto transaction service will have detrimental effects for the industry in the interim, and the effects will be felt beyond the crypto industry.
• The major unbanking of the crypto industry will have negative impacts on liquidity, adoption, and industry development while the crypto narrative will likely face further headwinds from regulators.
• It can be clarified, however, that the financial troubles surrounding the three banks have not been primarily initiated by crypto related risks and volatility, but rather are a consequence of TradFi troubles, as well as a lack of risk hedging from the SVB.
• Due to tremendous inflows of liquidity and deposits into the three banks in the past years, they were tempted to invest substantial amounts into long duration U.S. government treasuries, because at that time interest rates were still relatively low.
• Consequently, with the recent drastic rate hike (from 0.08% to 4.58% in 12 months), these treasuries and government bonds dropped in price significantly, causing major unrealized losses for these banks, making them technically undercapitalized if all depositors were to withdraw.
• A bank run was induced, forcing the banks to realize their “paper losses”, instead of being able to hold them to maturity, causing their eventual bankruptcy.
• The troubles surrounding SVB’s bankruptcy quickly spread to stablecoins, with USDC issuer Circle’s major cash holdings being held at SVB; causing an 8% depeg for USDC over the weekend, amidst its redemption being halted amongst major crypto exchanges, until it repegged on Monday amidst regulators’ assurance that SVB depositors will be made whole.
• Despite the troubles surrounding the crypto industry, it remained relatively unaffected so far, even though there is a risk of more crypto related businesses being affected.

2. Ripple effects for the larger financial system and macroeconomic update

The Facts:

• The troubles surrounding Silvergate, Silicon Valley Bank (SVB) and Signature Bank caused greater fear and contagion beyond institutional-servicing banks, and spread into the broader financial system, with clients of major retail / deposit banks initiating bank runs.
• There are overall stringent macroeconomic and monetary conditions, including tight liquidity, high interest rates and sustainably elevated inflation levels.
• Although not directly related to the demise of the three banks, deteriorated market sentiment also hit Credit Suisse, a major industry and retail bank, and the first European banking entity to be affected in a major way.

Our Take:

• Following years of zero interest rate policies, substantial quantitative easing (QE), effectively flooding the financial system and the economy with cheap liquidity, last year marked the beginning of the steepest interest hike ever, raising interest rates by roughly 60x from their lows in less than a year, combined with quantitative tightening (QT) effectively removing liquidity from the system.
• As a result, bond prices saw extremely steep declines in their valuation, amongst other troubles, revolving around increased financing costs for major parts of the economy, that were operating largely on cheap access to funding, which are slowly but steadily being priced out of the market by the current monetary policy regime.
• The consequence for financial institutions and banks that held these bonds are substantially high, unrealized losses on their balance sheet, that if they had to be realized would force them into bankruptcy, as they cannot return all their customers’ deposits in whole.
• The troublesome part is that the banks are factually solvent, if they would be able to hold the bonds until maturity, at which point their value returns to the original face value, whereas the temporary price decline is due to interest rate hikes, this is known as a typical asset liability mismatch, induced by a (bond) maturity duration mismatch.
• The dilemma stems from behavioral and game theory that is causing the bank run: if all clients were to withdraw their money, the bank is forced to realize their losses, causing some depositors to not have their funds returned, whereas if all held out, all would be made whole, yet every one´s individual most beneficial decision, is to withdraw their funds as fast as possible, initiating the infamous bank run that bankrupts banks.
• Going forward, it is highly likely that all the effects of the current monetary regime have not yet rinsed through the entire financial system or the economy, implying that the overall risk remains elevated in the interim.
• A troublesome finding is that the FDIC, which is supposed to fund the bailing out of banks, covers a mere 1.3% of the entirety of deposits with banks, though it has to be noted, that it is highly unlikely that all banks simultaneously realize substantial losses on their deposits.
• Generally, the trust in banks and the financial system is even more disturbed and has substantially decreased as of recent, with major depositors withdrawing their funds from more risky banks, amidst rating agency Moody downgrading the entire U.S. banking system.
• Fortunately, the crypto market itself has so far has only been affected in a moderate way by the financial troubles surrounding the financial system and the broader economy.
• Going forward, the issues surrounding the financial system are unlikely to be stopped at any point, unless the current interest rate will be cut, and inflation will decline further, which will ease the overall stress on the economy.
• Though it would be favorable to see the financial conditions ease, it seems unlikely that a potential rate cut and liquidity injection, and or potential overall QE, will not cause inflation to pick up again, reigniting the vicious spiral our economy finds itself in.

Our take: Where is crypto going?

Crypto will survive.

• The current economic and financial conditions are tough for the financial system, the economy, and citizens, but nevertheless, there are various reasons to point towards the light at the end of the tunnel and observe the optimistic trends and developments for the crypto industry going forward.
• Firstly, the troubles and headwinds the crypto industry is facing in the U.S. currently are not shared unanimously, with U.S. States such as Missouri legally protecting Bitcoin mining, or Arizona, Texas, Florida for example having very positive, endorsing attitudes towards crypto.
• The European Union, the United Kingdom, the United Arab Emirates as well as major Asian economic and financial hubs such as Singapore and Hong Kong moved forward substantially in providing proper regulatory frameworks and ground for business for the crypto industry recently.
• “Foot voting” is the economic concept of businesses, capital and individuals moving to where the ease of business is highest, which is especially the case for the dynamic crypto industry, enabling it to easily adapt to a changing economic and business environment.
• It is highly likely, that major crypto adoption will continue in those jurisdictions that create friendly and open environments for the crypto industry to operate on.
• Furthermore, the largely “unbanked” crypto industry still has major crypto endorsing banks, amongst them BNY Mellon, JPMorgan, Cross River or BCB Group, while the incentive for new banks to step in, and capture tremendous revenues by servicing the crypto industry is very high.
• With crypto businesses having a high motivation to find new banking partners, it is plausible that new partnerships will be entered soon, and that the current restrictions of on- and offramp liquidity will be temporary.
• The current effects of the financial troubles and contagion in fact had the opposite effect of what would be expected for crypto adoption, as it actually increased with more than one million BTC wallets being created last weekend alone.
• Lastly, financial crisis and times of economic turmoil in the past have offered extremely attractive investment opportunities and “cheap” prices, historically, which is why the current situation should counterintuitively be seen as a chance, not as a crisis.

In other news

• Abritrum Airdrop announced (via Arbitrum)
• Euler Finance exploited for $197 million (via Decrypt)
• Binance to buy $1 billion worth of crypto (via Coindesk)
• EU passing smart contract regulation (via Cryptoslate)
• U.S. governments request to delay Voayager – Binance deal rejected by bankruptcy judge (via Cryptoslate)
• Buyers of Signature must agree to give up all crypto business (via Coinmarketcap)

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