Small banks are on a wild ride thanks to crypto

As big banks shied away from cryptocurrency ventures, a handful of small lenders eagerly courted the booming businesses. Now, they are dealing with the bust.

Silvergate Capital, Signature Bank and Customers Bancorp have secured billions of dollars in deposits from crypto businesses – the exchanges, investment firms and stablecoin issuers that have grown rapidly alongside the digital currency market.

The fall in crypto prices this year has taken banks on a wild ride. At Silvergate, deposits varied by $5 billion in the second quarter, an almost unheard-of move for a bank of its size, before ending basically flat at $13.5 billion. Signature posted its second quarterly drop in deposits in a decade and a major crypto client filed for bankruptcy.

Volatility has also seeped into bank stocks, which now trade more like crypto companies than their banking peers. Shares of Silvergate and Signature doubled last year when the market was booming, while shares of clients more than tripled. Silvergate is down almost 30% this year, while Signature and Clients are down almost 40%. The broad Nasdaq Bank Index fell 8%.

Big banks have been taking market share away from small banks for years, especially when it comes to deposits. This has meant that smaller banks are looking for growth in places where the big banks are not. With crypto, the difficulty of the strategy is obvious.

Banks usually want sticky deposits: stable, low-cost funding that allows them to make more long-term loans. In the most extreme scenario, an unstable deposit base can make banks more prone to runs where customers demand their money faster than the bank can deliver it. Falling stock prices can make it harder for a bank to raise the money it needs to operate.

Crypto-focused banks do not own digital currencies. Instead, they provide corporate bank accounts for crypto companies. They also operate special payment networks: A hedge fund buying bitcoins through the Coinbase Global exchange, for example, could use dollars from the fund’s Silvergate checking account to cover the purchase almost instantly.

More deposits usually allow a bank to increase lending. But these banks aren’t growing their loan books as fast as they’re building deposits, instead opting to keep a larger cushion to account for unexpected outflows. Silvergate and Signature posted record profits in the second quarter, despite dramatic moves in the crypto market.

“This is all par for the course,” Silvergate chief executive Alan Lane said. “We’ve set things up to essentially thrive during these times of market dislocation.”

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In 2013, Silvergate was a commercial real estate lender with a handful of branches in the San Diego area looking for deposits. The bank opened up to crypto companies the following year, and since then its deposits have grown 30-fold, with 99% of them coming from the digital currency world. The bank has sold most of its traditional banking business to focus on crypto companies and institutional investors, banking on well-known exchanges such as FTX, Coinbase and Kraken.

Earlier this year, a decline in cryptocurrency trading volumes meant that clients needed fewer deposits. The May collapse of terraUSD, a stablecoin pegged to the dollar, triggered losses on crypto exchanges and brokers, sending prices tumbling and sparking a trading frenzy. Silvergate’s deposits rose to $17.6 billion and fell to $12.6 billion in the second quarter.

The bank said it hasn’t lost money on its $1.4 billion portfolio of bitcoin-backed loans, even though the value of the digital currency has halved this year. Silvergate requires collateral far in excess of the value of the loans.

In 2018, Signature Bank hired bankers specializing in crypto, as part of an effort to branch out beyond commercial real estate.

Since the bank introduced its own payment system for crypto businesses, total deposits have nearly tripled to $104 billion. Crypto-linked deposits accounted for 26% of the total at the end of the second quarter.

One of Signature’s clients, crypto lender Celsius Network, filed for bankruptcy in July. In court documents, Celsius said it had $130 million in cash on hand and nearly all of its bank accounts were at Signature. Signature has experience working with clients in bankruptcy, and Celsius represents a small portion of its deposits, President Scott Shay said in an interview.

A $2.4 billion drop in digital asset deposits in the second quarter dragged down total deposits.

“We’re banking a lot of companies, and it’s not our job to pick winners and losers,” Shay said.

Pennsylvania-based Customers Bank began seeking crypto-company deposits less than a year ago. Its payments system has attracted more than $2 billion so far, a sizeable sum for a bank with $17 billion in deposits.

Crypto customers withdrew hundreds of millions of dollars on some days in the second quarter, often to meet customer redemptions, said Christopher Smalley, the bank’s head of digital banking. Still, crypto-linked deposits grew, albeit more slowly.

“It’s worth taking the risk of negative news or additional regulatory scrutiny to get these very large deposits,” Smalley said. “We are ready for an extinction level event where bitcoin would go to zero.”

The bank, he said, has also strengthened its anti-money laundering team. It is launching crypto-backed loans for customers. Co-branded credit cards with exchanges and other projects could be next, Smalley said.

New York-based Metropolitan Commercial Bank held deposits for clients on exchanges and partnered with exchange Crypto.com to issue a prepaid debit card backed by investors’ crypto holdings. Metropolitan has $270 million in customer deposits for the Voyager exchange, which filed for bankruptcy last month. Now you could lose your entire share, around 4% of your total deposits, when these customers return.

Metropolitan said it is moving away from crypto, looking to banking fintech companies.

—Soma Biswas contributed to this article.

Write to David Benoit at David.Benoit@wsj.com and Rachel Louise Ensign at Rachel.Ensign@wsj.com

This article was published by Dow Jones Newswires, a service of the Dow Jones Group



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About the Author: Chaz Cutler

My name is Chasity. I love to follow the stock market and financial news!