Silicon Valley Bank’s downfall has many causes, but crypto isn’t one

Silicon Valley Bank (SVB) boasted over $200 billion in assets and was a lifeline for crypto companies.

Notably, it was one of the few institutions offering services to crypto companies in the United States as other banks shied away from the sector, fearing risk and the possibility of a sudden regulatory crackdown.

The downfall of SVB, Signature Bank and Silvergate Bank, all within a short time, has instilled fears of another 2008-like financial crisis. While policymakers continue to assure the public that they are working on a recovery plan — with the Biden administration announcing measures to protect depositors — the bank run created a panic in U.S. markets.

A bank run happens when the majority of depositors at a particular bank decide to withdraw their funds at the same time. Most banks don’t have all depositors’ money on hand since — under the fractional reserve banking system — banks are only required to hold a percentage of customer deposits at any time.

The system has been successful for a long time, but every decade or so, a bank run happens, laying bare the banking system’s vulnerability.

These banks experienced asset-liability mismatches due to higher deposits than credit during the COVID-19 pandemic. This led to banks’ excess use of liquidity in public and private sector bonds. However, with rapid interest rate hikes by the U.S. Federal Reserve, these banks incurred enormous losses, eventually leading to a liquidity crisis.

The asset-to-liability mismatch, although common in most situations for banks, was untenable in the current scenario due to the sharp decline in deposits.

Crypto gets tangled in the US banking crisis

The crypto industry has faced much criticism in recent times owing to a slew of high-profile collapses and losses for investors. However, in the case of SVB, crypto’s involvement was less causational and more due to counter-party risk on the part of stablecoin issuer Circle.

Following the downfall of SVB on March 10, USD Coin (USDC) issuer Circle announced that nearly $3.3 billion of the reserves backing USDC were stuck in SVB.

The announcement drastically affected the stablecoin, which lost its peg to the U.S. dollar, eventually falling to $0.87. The depegging of USDC created a panic in the crypto industry as the stablecoin has the second-largest market share, and is popular among centralized and decentralized ecosystems.

Even though Circle assured that they would compensate for the shortfall with other assets, traders and whales started to swap USDC for other stablecoins available on the market — even at a loss.

One panicked trader who attempted a risky and ultimately costly move to exit USDC received a mere $0.05 in Tether (USDT) for $2 million worth of USDC.

Contrastingly, those who remained confident that USDC would eventually regain its peg started buying USDC at a lower value in hopes of making profits once the price increased back to $1.00.

USDC eventually repegged to the U.S. dollar on March 13, as Circle confirmed it had found a way to move its funds out of SVB. The banking crisis-induced panic in crypto markets subsided within days.

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In fact, crypto flipped the narrative and proved a safe haven during the ongoing banking crisis, even when most traditional markets and financial institutions were bleeding red. While slumping slightly on March 10, the prices of major cryptocurrencies like Bitcoin (BTC) and Ether (ETH) have seen a marked improvement over the last 10 days.

SVB Financial Group, the parent company of SVB bank, eventually filed for bankruptcy on March 17 in the U.S. Bankruptcy Court for the Southern District of New York.

US regulators spring into action, but is it too little too late?

While crypto as an asset class may have exited this crisis relatively unscathed (at least for now), questions remain as to the root causes of the crisis and whether it could have been avoided.

Cathie Wood, the CEO of asset management firm ARK Invest, criticized regulators and the Federal Reserve for failing to stop the current bank run, saying that enforcement agencies were using cryptocurrency as a scapegoat for their banking supervisory failures.

If you are correct, Congressman, then the FDIC and others will prevent the US from participating in the most important phase of the internet revolution. Like you, I believe regulators are using crypto as a scapegoat for their own lapses in oversight of traditional banking. https://t.co/UDh3bwB2pB

— Cathie Wood (@CathieDWood) March 16, 2023

Despite these criticisms, the Fed is investigating the circumstances surrounding Silicon Valley Bank’s downfall, with Fed vice chair for supervision Michael Barr recently launching a review of the situation. The report’s findings are expected by May 1.

The U.S. Department of Justice and the Securities and Exchange Commission have also launched independent inquiries into the collapse of SVB, including reports about the sales of the bank’s shares by executives just days before regulators shut it down.

However, the SVB bank run is not a new phenomenon. Tony Petrov, a blockchain and fintech attorney, told Cointelegraph that the bank crisis is a man-made mess, explaining:

“According to Boeing, approximately 80% of airplane accidents are due to human error. I think this fact, taken as a metaphor, can also work for the financial industry. What we are witnessing now is the crash of the economy based on ‘reckless capitalism,’ in which compliance procedures and risk management were held in a stall in the backyard, also known as a tick box exercise.”

Bradley Barnhorst, chair of the finance major and CFP program director at DeSales University, told Cointelegraph that SVB’s downfall could be attributed to improper management of the economic value of equity, a failure to protect against interest rate risk and an abrupt decrease in deposits.

He recommended that banks should “adopt rigorous risk management processes and increase capital levels to protect against potential losses.”

Barnhorst further stated that banks need to diversify loan portfolios, be more selective with investments, and “monitor and manage the risks associated with their investments to ensure that they are not overexposed to any particular sector or industry.”

According to a recent Stanford University study, 186 U.S. banks are in danger of facing a bank run because of rising interest rates and a sizable percentage of uninsured deposits. The study found that assets like treasury notes and mortgage loans may lose value when new bonds are issued with higher interest rates. Even insured depositors might experience impairments if half of the uninsured depositors abruptly withdraw their money from these 186 banks. The banks wouldn’t have enough assets to reimburse all depositors fully.

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Chris Barnes, managing director of the financial services division at market data analytics firm Escalent, told Cointelegraph that 2008 was the last time the banks faced a negative trust environment, and 2023 could be another similar year.

Barnes explained, “The stress tests for large institutions work and are solid — it’s downstream banks they are worried about. Those banks were exempted from legislative changes in 2018.”

“If the rules would have been in place, this wouldn’t have happened. When this unfolded, there was a lot of anger in [Washington] D.C. because Silicon Valley Bank pushed so hard to get off the regulatory loop (not very ironic). There needs to be a second type of stress test for banks below significant financial institutions,” he added.