#309—How the government killed Silvergate Bank

Also, Gary Gensler gets grilled

Sep 30, 2024

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This week:

How the government killed Silvergate Bank
What we’re watching—Gensler gets grilled
Stuff happens

1. How the government killed Silvergate Bank

This is the story of how government officials choked off the crypto industry from the banking system, as revealed by a new in-depth investigation by Nic Carter (via Jun Hiraga).

Two years ago, Silvergate was the most important bank in crypto, its customers, many of the largest crypto exchanges and institutions in the world. Once a small community bank, Silvergate was then perceived as nimble, innovative, and forward looking, validated by a highly successful IPO.

Then crypto collapsed and so did Silveragte—all of which, from the surface, seemed reasonable, the comeuppance the industry deserved for the wild hubris of the previous years.

But according to Nic Carter’s investigation, there’s a lot more to the story, some of it quite insidious.

Here’s Nic:

But what if that’s not the whole story?
What if there’s another version of events, in which Silvergate was a victim of FTX, not an accomplice to their crimes?
What if Senator Warren’s warnings about Silvergate served as a self-fulfilling prophecy, hastening the run on the bank?
What if the Biden administration deliberately killed off Silvergate — and some of its peers — in an attempt to decapitate the domestic crypto industry? What if this was the spark that lit the flame of a gigantic regional banking crisis?
And what if the settlements Silvergate made with its regulators effectively covered the government’s tracks, allowing it to continue to deny the existence of Operation Choke Point 2.0?
This is the version of events no one is talking about, and one that official government accounts rebuke, but it’s what I’ve come to believe. Aside from a relative few on Crypto Twitter, it’s a story no one seems interested in — the mainstream financial press most of all. But in my mind, the official narrative is historical fiction at best, and recent events have only further convinced me of the fact.

One of the first things regulators did (secretly), was impose a 15 percent cap on crypto deposits:

I later learned that key elements of the regulatory crackdown, in particular the 15 percent threshold on crypto deposits (conveyed to Silvergate by the SF Fed, with apparent assent from other regulatory bodies) were considered “confidential supervisory information” (CSI)³, and hence ineligible to be shared publicly. Perversely, CSI is intended to protect banks themselves from leaks of information surfaced in examinations — routine procedures where regulators evaluate bank management, safety and soundness, and regulatory compliance — that could hurt their standing, but in this case, it was weaponized against the banks to protect the regulators’ reputation in the eyes of the public.
So far, we have seen no acknowledgment from the Fed, its regional branches, or the FDIC regarding the 15 percent deposit caps, which government authorities primarily messaged verbally to a number of crypto banks, rather than in writing. Why did Silvergate and others feel compelled to comply with these informal deposit caps? An insider explained it to me this way: “They have eight million ways to shut us down, any way they want. When they say you gotta do something, you do it.” The caps were never publicly discussed or formally opposed as a rule, but when your primary regulator threatens you, you comply. “The regulators can pick anything and say, ‘Your compliance program is broken’ as a pretext for shutting you down,” the source told me.

That cap essentially killed Silvergate’s business model:

“If the [15 percent] limit hadn’t been imposed, Silvergate would be thriving right now,” someone familiar with the matter told me. I tend to believe this. There has been a gaping hole in domestic crypto banking since the imposition of Choke Point 2.0, and any firm brave enough to offer banking to crypto firms would have done tremendously well — had any been allowed to survive. Anecdotally, connections to domestic banks willing to onboard crypto clients is the number one request from portfolio companies at my blockchain-focused venture capital firm Castle Island. Unfortunately, regulators haven't allowed the market for crypto-friendly banks to recover. As a result, crypto startups are moving offshore, where more banks are willing to support digital asset firms.

One of the bank’s killer apps was a product called the Silvergate Exchange Network, which allowed crypto institutions to settle payments 24/7/365. It was one of the key benefits of opening an account at Silvergate. The 15 percent cap meant that Silvergate could no longer maintain accounts for the industry’s core players:

This would be the eventual catalyst for Silvergate’s voluntary liquidation (in and of itself, as Nic points out, an incredibly rare occurrence as most troubled banks enter FDIC receivership).

Incidentally, there was another bank that offered a similar settlement product for its crypto clients (called Signet)—Signature, which met its demise in the fallout of Silvergate. For Silvergate Chief Administrative Officer Elaine Hetrick, the treatment of Signature was yet another example of regulators’ explicit anti-crypto policy, which she asserted in a bankruptcy filing:

She also points to the failure of Signature Bank as indicative of an anti-crypto stance on the part of regulators, referring to Chair Barney Frank’s comments that its closure was at least partially due to a desire to “send an anti-crypto message.” Hetrick notes that, tellingly, the FDIC refused to include $4 billion in crypto-related deposits in the sale of Signature to Flagstar Bank. As one confidential source told me regarding the FDIC’s refusal to sell crypto-related deposits or Signature’s SigNet, “The government is setting policy not based on law, but through selective sales.⁴”

Again, these settlement networks served as foundational infrastructure for the industry. Since then, new entrants who have tried to replicate that product have been similarly punished—as recently as last month:

More directly, in August 2024, the Federal Reserve Bank of Philadelphia issued an enforcement action against Customers Bank, citing deficiencies with the bank’s “risk management practices and compliance with the applicable laws, rules, and regulations relating to anti-money laundering” in connection with its digital assets business. Just like Silvergate’s SEN and Signature’s SigNet, Customers operated an instant settlement business for clients called Customers Bank Instant Token (CBIT).

It is perhaps a coincidence that following the demise of Silvergate’s SEN and Signature’s SigNet the the Federal Reserve would unveil its own real-time settlement network for banks—FedNow:

Such intra-bank settlement networks appear to be utterly toxic to regulators. Sources with knowledge of the Cross River and Customers matters to whom I spoke surmised that the Fed’s July 2023 release of FedNow — an instant payment service that allows banks and credit unions to settle transactions in real time, 24/7 — could explain the Fed’s particular hostility toward banks that had created their own instant settlement networks. Certainly many view the timing as suspicious. I’m not entirely persuaded by the theory, but the fact that SEN, SigNet, and CBIT were all eliminated or defanged around the time FedNow launched did raise eyebrows.

But ultimately it was Senator Elizabeth Warren, who hammered the final nail in the coffin (with the urging of short seller Marc Cohodes):

On January 30, 2023, Warren wrote a second letter, complaining about Silvergate’s responses to her first one, this time appearing to pressure the Federal Home Loan Banks (FHLB), which Silvergate was using for last-resort liquidity. It seems her objective was to get the FHLB to pull the rug on Silvergate, forcing them to close. The FHLB eventually declined to renew their monthly facility with Silvergate, which may have been the straw that broke the camel’s back.
“Someone was putting pressure on the FHLB,” one person familiar with the situation told me. “If Silvergate had been allowed to hold to maturity the government-backed securities, they would have been able to stem their losses. They were trying to liquidate them slowly to minimize losses. But the FHLB started getting pressure, so they pressured them to pay back the loans.” To me, it certainly appears like the FHLB responded to Warren’s pressure campaign and cut Silvergate loose. (At the time, FHLB claimed it “did not request or compel” the bank “to prepay its outstanding advances.”)

This was Operation Choke Point 2.0—a concerted effort to stymie crypto in the U.S. But since then, according to Nic, this has further extended to fintechs:

As an aside, it’s worth noting that in 2023 and 2024, the FDIC extended its Choke Point 2.0 playbook from banks serving crypto to banks serving non-crypto fintech startups as well. In April 2024, the American Fintech Council (AFC) wrote a letter to the FDIC accusing it of using its enforcement powers to quietly curb fintech activity in the US by bringing selective enforcement against banks serving fintech firms. As the AFC said in their letter: “While your agency has not issued public guidance or other statements explicitly admonishing or limiting banks from engaging in partnerships with fintech companies we have identified a distinct ‘regulation by enforcement’ approach from the FDIC.” The AFC noted that banks not partnered with fintechs had a 1.8 percent chance of facing an enforcement action from the FDIC, whereas fintech-partnered banks had a 15 percent chance of a regulatory rebuke.
Just as with Choke Point 2.0 efforts against crypto, the government’s mode of engagement with fintech has been unusually antagonistic and ideological in nature. Instead of proposing new legislation and hosting a public debate, or even engaging in notice-and-comment rulemaking where affected parties would have the right to provide feedback, these agencies make arbitrary new rules and impose them by enforcement — and whispered “advice” which banks have no choice but to follow.

Check out Nic Carter’s full investigation—it’s worth the read.

Relevant:

A new view on Silvergate's unwinding

2. What we’re watching—Gensler gets grilled

The war to stifle crypto was a multi-pronged battlefront. On the one hand, they were shut off from banking—something the marijuana industry is all too familiar with. On the other, you had Gary Gensler’s SEC, which notoriously regulates by enforcement—and as such, is incentivized to keep policy as ambiguous as possible.

Last week, Gensler got grilled during the Congressional SEC oversight hearing (via Greg Kidd):

As it stands, Gensler has few friends these days. Here’s a report from Bloomberg earlier this month:

Meanwhile, Gensler, whose term as head of the Securities and Exchange Commission is up in 2026, is disliked privately by both Democratic and Republican donors, some of the people said. Gensler has pushed for tougher regulations, but donors have particularly bristled at what they perceive as him talking down to Wall Street, the people said.
Billionaire Mark Cuban, a supporter of Harris, told CNBC this week that the SEC “needs to change” and that he’s asked the vice president’s team to “put my name in for the SEC.” Donald Trump pledged at a crypto conference that if elected he would fire Gensler.

And according to Mark Cuban, VP Kamala Harris is explicitly against “regulation through litigation.”

Relevant:

Yaka Stuff

#309—How the government killed Silvergate Bank

Also, Gary Gensler gets grilled

1. How the government killed Silvergate Bank

2. What we’re watching—Gensler gets grilled

3. Stuff happens

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