Crypto Didn't Cause the Banking Crisis
This note was sent to Galaxy clients and counterparties on Monday, March 13, 2023.
Signature Bank director Barney Frank told CNBC Monday that he thinks “part of what happened was that regulators wanted to send a very strong anti-crypto message” and that Signature Bank officials believed they had stabilized on Sunday and that there was "no real objective reason" that Signature had to close and the bank was ready to open “as a going concern.” The flip-flopping here, and the suggestion that Signature was solvent and taken over for political reasons, is extremely troubling. The U.S. regulatory attack on the cryptocurrency industry continues and stands in stark contrast to the progressive frameworks being introduced around the world.
But beyond the political attack, there’s been a lot of commentary suggesting that cryptocurrency is to blame for the bank crisis of the last 72 hours. For a variety of reasons, we don’t believe this is a fair criticism. While it’s easy to make this association–Silvergate and Signature were mainstay players in the cryptocurrency industry and SVB was the key bank for the venture and private equity complexes–the reality is that the factors leading to the current crisis are more nuanced and diverse:
The failure of central banks and policymakers to caution about impending inflation and the way in which they dealt with inflation when it happened. Many federal officials, including Federal Reserve Chairman Jay Powell and Treasury Secretary Janet Yellen, repeatedly downplayed the likelihood of high inflation in 2021, despite a cacophony of voices predicting it would rise in the face of unprecedented monetary policy loosening and government stimulus checks. The speed of their narrative pivot toward the end of 2021, first to “inflation is transitory” and then to the start of the fastest rate-hike regime in American history, clearly caught many banks off-guard. The national regulatory and administrative leaders of the banking industry repeatedly assured the world – and the banking sector – that inflation was not a fear and rates would not rise. They were catastrophically wrong. Banks are now sitting on more than $620bn of unrealized losses on fixed-income securities that they essentially had no choice but to buy given a lack of yield-generating alternatives in a ZIRP environment. The fact that the Federal Home Loan Banks (FHLBs)—another source of wholesale funding for banks (the central bank being the other)—are raising an additional $64bn is another significant data point showing distress across the banking sector. The cryptocurrency industry isn’t responsible for this.
Bank management of assets & liabilities. It’s clear that Silvergate and SVB each had 1) deposit bases highly correlated within specific industries and 2) duration mismatch issues stemming from a giant portfolio of underwater fixed-income securities. However, in the case of Silvergate, whose deposit base consisted largely of crypto-related companies, the bank didn’t actually require a bailout, backstop, takeover, or receivership. Indeed, depositors at Silvergate didn’t actually lose funds there. At SVB, the concentration wasn’t crypto-specific at all, but rather venture-specific. While Circle was one of the biggest depositors—it had $3.3bn there—Circle couldn’t pull its funds from the bank, and thus didn’t contribute to the run. We still don’t know why Signature was seized (although is still operating), but NYDFS Superintendent Adrienne Harris is downplaying crypto as the reason for the takeover, telling CoinDesk that Signature Bank had “a broad depositor base, so this idea that it is a crypto-based bank is not an accurate one.” (This comment appears to contrast with director Barney Frank’s suggestion). Put simply, rising rates broke the banks. And federal officials are rightly worried that rates could break more banks. The simple reason why is that, when the Fed raises rates, the yields on short-dated risk-free treasury bills rise. At the same time, banks with illiquid and/or fixed-rate loan and securities books—i.e., the yields on them are fixed over a term—that they acquired before rates skyrocketed will generate much lower returns relative to the rising cost of deposit funding. This simultaneously causes the banks’ fixed-income portfolios to trade at a discount to par value and can lead to depositor outflows as they seek higher yields. If depositor outflows are significant enough, the banks need to sell their fixed-income securities to generate cash and meet depositor withdrawal demand, but because they trade at a discount, the sales happen at a realized loss, further impeding bank balance sheets.
The banks we’ve seen fail and/or be taken over so far were particularly offsides on those fixed income bets (or whatever happened at Signature... we still don't really know), essentially having bought the top in the fixed income market just before rates rose dramatically and not effectively or sufficiently hedging their interest rates exposure. But many banks also have bonds that are trading below par.
The cryptocurrency industry has been facing banking challenges since the start of the year when U.S. banking regulators first issued a joint statement concerning banks’ exposure to crypto deposits. Despite assurance from those regulators at the time that “banking organizations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type, as permitted by law or regulation,” (we wrote at length about this statement in the Jan. 13 edition of our weekly newsletter) subsequent actions, including the denial of Custodia Bank’s Fed membership and master account (which we wrote about on Feb. 3), have further chilled the banking sector’s appetite for servicing the fast-growing industry. The losses of Silvergate SEN and Signature’s SIGNET (if it does indeed close or halt servicing the crypto industry) will exacerbate the situation and impact the speed of transfers and liquidity in crypto markets. Bigger firms have been able to obtain and maintain accounts at several big banks, and several smaller banks continue to provide access including to facilitate trading on exchanges. But smaller cryptocurrency businesses are increasingly finding it difficult to obtain even basic business checking accounts in the United States.
While the operating environment in the U.S. is becoming more challenging, the bull case for Bitcoin is on full display. Often erroneously thought of as an inflation hedge, Bitcoin should be thought of as a protest against the banking system and monetary policy. That’s what it is on a fundamental level–a non-sovereign fixed-supply global commodity money that cannot be seized, censored, or debased. Broadly speaking, the core value proposition of decentralized cryptocurrencies is the ability to be your own bank, make your own payments, and opt out of the traditional financial system. Bitcoin is up significantly today, a sign that markets are fleeing to the safety it provides not only from within the cryptoasset ecosystem, but also perhaps from without.
And other jurisdictions recognize the power of this transformative concept. In the U.K. recently, HM Treasury produced a comprehensive framework for incorporating crypto assets into the country’s existing capital markets regulatory regime. While that framework still requires regulatory approval, guidance was issued for a range of underlying activities, including custody, trading, lending, borrowing, and more. If the FCA adopts the recommendations, the U.K. will become one of the most progressive, safe, and supportive regulatory environments in the world for crypto assets. Already several U.K. firms have announced significant plans to expand headcount.
Europe took a different but equally commendable approach. Rather than incorporate crypto assets into existing oversight regimes as the U.K. is doing and SEC Chairman Gary Gensler says he wants to do, the European Commission is in the final stages of formalizing a comprehensive crypto-specific regulatory regime — the so-called Markets in Crypto Assets (MiCA). MiCA provides comprehensive guidance for how crypto firms can conduct a wide range of activities compliantly in the European Union.
The picture looks similar as you head East. From the Middle East to the South Pacific and even Hong Kong, ambivalence or obstruction is giving way to regulatory clarity and progressive, thoughtful engagement. Indeed, all around the world, there are public ETFs and other market access vehicles, support from governments, and emerging regulatory clarity.
While we want to see a more supportive approach to cryptocurrency in the United States, Bitcoin is global, and the world sees the promise.