Silvergate: from tiny local lender to bank behind the crypto boom

“Life as a crypto firm can be divided up into before Silvergate and after Silvergate,” Sam Bankman-Fried wrote in a quote featured on the website of the San Diego bank he used to transfer customer funds to his digital asset exchange FTX.

“It’s hard to overstate how much it revolutionised banking for blockchain companies.”

Silvergate was an unlikely candidate to become the bank behind the $40bn crypto exchange that collapsed into bankruptcy last month.

For most of its 30-year history, it was a tiny community lender focused on financing small real estate deals, with three branches in southern California and less than $1bn of assets.

But by 2019, it was rapidly becoming the largest cryptocurrency bank in the US, with 1,600 of the world’s top crypto miners, exchanges and custodians using it to deposit and transfer billions of dollars each month.

Deposits surged from roughly $2bn in 2020 to more than $10bn in 2021. By this year, total assets had leapt to $16bn. Barely 10 months after listing on the New York stock exchange at the end of 2019, at $12 a share, Silvergate’s share price had climbed to more than $200.

“This was a tiny real estate lender that went all-in on crypto,” said one former employee. “It was completely weird.”

But the rollercoaster came to an abrupt halt last week with Silvergate caught in the crosshairs of US senators investigating the failure of Bankman-Fried’s FTX, which has been accused of mishandling deposits from customers who now face up to $10bn of losses.

When they got into it, crypto was this little new thing, and I think they didn’t realise it would take off as fast as it did

Silvergate “appears to be at the centre” of how those funds were moved around Bankman-Fried’s crypto empire, according to a letter from US senators to the bank’s chief executive Alan Lane. It said the failure to detect such a “scheme” could mean Silvergate breached anti-money laundering laws.

Lane tried to address market concerns about its links to FTX in a public letter last week that accused short sellers of spreading “speculation” and “misinformation”. He said the bank conducted “significant due diligence on FTX and its related entities”.

Silvergate has quietly removed the glowing tribute from Bankman-Fried from its website, along with all reference to its former client. The FTX collapse wiped out two of the bank’s top clients: about 10 per cent of Silvergate’s total assets belonged to FTX and its customers also included crypto lender BlockFi, a major casualty of the fallout. FTX and its “related entities” held about 20 different accounts at Silvergate, according to its bankruptcy filings.

The bank has until December 19 to respond to the letter and provide a “full accounting of its relationship with FTX”.

Lane, a 60-year-old devout Catholic and grandfather to more than 20 children who lives in Temecula, California, is the mastermind behind Silvergate’s remarkable shift in strategy over the past few years.

Hired by Silvergate’s founders Dennis Frank and Derek Eisele in 2008 when the bank was floundering, Lane planned to turn it into a full service commercial bank, according to people close to the business. He had previously turned round a string of small local banks.

But in 2013, Lane started dabbling in crypto. Bitcoin, then a nascent four-year-old technology, had a record run that year, surging almost 7,000 per cent to top $1,000 for the first time. Crypto was slowly starting to gain mainstream awareness.

“We needed deposits and Alan started seeing that companies like Coinbase were getting kicked out of banks,” said Ben Reynolds, Silvergate’s president who was hired by Lane in 2016 to turbocharge its crypto strategy. “So the idea was: if we can bank Coinbase, we can find deposits. Alan went to the Federal Reserve and said we want to provide basic banking services to Bitcoin companies and they said OK.”

Wary of an emerging asset class that had been linked to money laundering and illegal drugs, major financial institutions refused to bank crypto exchanges and started blocking transfers by customers to buy cryptocurrencies. Traditional banks were also not set up for crypto traders, who needed to be able to transfer money at the weekends.

Lane and Reynolds recognised the gap and the inefficiency in the fast-growing market and seized the opportunity, according to the former employee. “The two of them in the same room just exploded,” he said. “Silvergate’s founders were both real estate guys but they loved [the change in direction] because it made money.”

Over the next six years, Lane and Reynolds sold off Silvergate’s business banking team and slimmed down its real estate group. Its crypto client base grew from about 20 companies in 2016, including Xapo, Paxos and Bitfury, to more than 1,000 and its management started exploring riskier ways of bolstering its balance sheet, including launching a stablecoin and structuring loans against cryptocurrencies.

In 2017 they launched the Silvergate Exchange Network, or SEN, a platform that allowed crypto investors to transfer US dollars from their bank accounts on to a crypto exchange instantly and 24/7, as long as both the exchange and the investor banked with Silvergate.

Then in March this year Silvergate issued a $200mn loan to a company owned by American crypto billionaire Michael Saylor, its biggest ever step into lending US dollars secured by Bitcoin.

“Alan saw this opportunity in crypto, which I still don’t fully understand, and he’s built it into something that is quite an operation,” said his mentor, former boss and Silvergate investor Frank Mercadante.

But it was fraught with risk. Silvergate has had to employ twice as many compliance staff as comparable banks of its size, according to two people who worked there. It typically takes six months for a new crypto exchange to open a bank account. “The key risks are know-your-customer and anti-money laundering and those were contemplated seriously back in 2014” — when Silvergate won its first crypto client — one of the people said. In June 2021, Silvergate terminated its relationship with Binance, the world’s biggest crypto exchange, for undisclosed reasons.

“When they got into it, crypto was this little new thing, and I think they didn’t realise it would take off as fast as it did,” said a person close to the business. “So then they put all the chips in that direction, it ran away form them, it got very big very quickly.”

As lawmakers pick over Silvergate’s relationship with FTX, the bank will be forced to examine its exposure to an unregulated industry where the risk of fraud and bad actors appears higher than ever.

“The bank has no real responsibility for preventing transactions between entities that look legitimate,” said one person close to Silvergate. “This is what gets to the heart of there not being enough regulation of crypto firms. For example, there is no requirement that anyone has to keep a segregated account that only has customer funds.”

Silvergate’s share price has dropped to half its level before the FTX collapse, and is down almost 85 per cent this year, although at $23 it is still almost double its IPO price. The bank is facing significant uncertainty about its digital deposits, which are down 60 per cent so far this quarter, according to analysts at Morgan Stanley. “The demise of FTX could also drive litigation and headline risk across the crypto ecosystem,” they added.

“We had a plan coming into the year that was challenged by the current environment, and we’re still trying to come to terms with what happened,” said Reynolds. “You have to ask those questions where are digital assets going from here, this is a pretty huge reputational issue for the industry, those are questions we’re asking.”