Silvergate Capital spent its final days under siege.

Bombarded by short sellers, deserted by depositors and shunned by business partners, executives at the crypto-focused bank were face to face with US regulators at its La Jolla, California headquarters.

Officials from Federal Deposit Insurance had arrived at the firm’s offices, intent on averting the US banking system’s first casualty from the crypto implosion. Among options they discussed were finding crypto investors to help shore up liquidity amid the bank’s mounting losses. But a desperate round of calls to potential investors failed, with no firm willing to shoulder the burden of associating with a bank mired so deeply in the industry’s upheaval.

With survival looking increasingly implausible and no buyer in sight, Silvergate said on Wednesday it was closing its doors, ending a decade-long crypto dream that once made it a central player as the industry boomed.

The decision to wind down and voluntarily liquidate, described by people familiar with the matter who spoke on condition of anonymity, capped months of turmoil at the bank stemming from its ties to Sam Bankman-Fried’s FTX. The crypto exchange’s November collapse into bankruptcy, followed by allegations of fraud, placed a harsh spotlight on Silvergate simultaneously igniting a regulatory crackdown on the industry’s ties to banking.

And as Silvergate buckled under the strain, posting US$1-billion of losses in the fourth quarter and bleeding more capital this year, it was forced to delay its annual report and raised questions about whether it could stay in business. After hitching its wagon so firmly to the new world of crypto, the bank had exposed itself to an old-world banking risk: when the industry’s prospects soured, Silvergate had little other business to lean on.

Transformation

“Silvergate’s troubles are as much if not more about traditional banking risks — lack of diversification, maturity mismatches — as it is about its exposure to crypto,” said Sheila Bair, who headed the FDIC during the Global Financial Crisis.

A representative for Silvergate declined to comment.

Silvergate was opened in 1988 to make loans to industrial clients, dealing in conventional services such as commercial and residential mortgage lending. But in 2013, it started to transform itself from a typical community bank into one catering to the digital-asset industry. It began accepting deposits from institutional crypto players few other traditional financial institutions were willing to do business with.

In 2018, it introduced a crypto-payments platform which enabled clients to exchange fiat currency at the same speed they traded digital assets on systems outside of the bank, such as FTX.

The bank’s shift from traditional banking into a then-niche area reflected a broader dynamic in the financial industry. Smaller US banks struggling to compete with larger rivals doubled down in areas traditional finance shunned with hopes it would give them a fighting chance, but with mixed success.

“Anytime you move away from having a big chunk of your business be relationships on both sides of the balance sheet, you’re going to wind up in trouble,” said Abbott Cooper, an activist investor who focuses on the banking sector. “And you’re definitely going to wind up in trouble if you’re not absolutely, intensely focused on the risks that have been created by that.”

The unique composition of Silvergate’s balance sheet also played a key role in its demise. Silvergate didn’t pay interest on the deposits it accepted from crypto clients, meaning it had a free pool of funding it was able to plough into investments such as government debt and similarly liquid assets. Among its portfolio were mortgage-backed securities and bonds sold by state and local governments.

This setup — although not uncommon for any bank — proved problematic as the US Federal Reserve hiked interest rates, eroding the value of a chunk of Silvergate’s securities. When the crypto industry faltered and clients rushed to withdraw money — driving the lender’s non-interest-bearing deposits down from $12-billion at the end of September to just $3.9-billion at the end of last year — Silvergate had to sell securities to pay for those withdrawals. But the bonds were worth less than the company paid for them, forcing it to sell them at a loss and inflicting a $1-billion hole on its earnings late last year.

“They failed to see that rising interest rates would radically affect the volatility of those deposits,” Todd Baker, a senior fellow at Columbia University’s Richman Center for Business, Law and Public Policy, said in an interview on 2 March. “They also failed to understand that the value of their securities portfolio would plummet when rates rose.”

US prosecutors in the justice department’s fraud unit have been looking into Silvergate’s dealings with FTX

Meanwhile, US prosecutors in the justice department’s fraud unit have been looking into Silvergate’s dealings with FTX and its trading firm Alameda Research.

The criminal investigation is examining accounts Silvergate hosted for Bankman-Fried’s businesses. The probe touches on a key question: what did banks and intermediaries working with Bankman-Fried’s firms know about what US officials have called a years-long scheme to defraud investors and customers?

The bank hasn’t been accused of any wrongdoing, and the investigation could end without charges being filed.

Court papers filed in February allege Bankman-Fried engaged in a bank-fraud scheme that targeted a company identified in a court document as “Bank 1”, which the indictment describes as being based in California. Bank 1 is Silvergate, a person familiar with that matter has said.

Read: Crypto exchange Luno to cut 35% of its workforce

Another important question is how a financial institution pushing so deeply into crypto didn’t prompt action on the part of its regulators.

“Where were the regulators on Silvergate?” asked Jerry Comizio, an adjunct law professor at American University and a former US treasury department official. “In a real sense, they missed Silvergate.” — Max Reyes, with Joe Schneider, Lydia Beyoud, Katanga Johnson and Hannah Miller, (c) 2023 Bloomberg LP