If you are old enough to remember the global financial crisis of 2008, then you might agree that the last couple of weeks in the global economic news have had that same distinct odor of disbelief, uncertainty and fear.
Crypto is inherently risky, so when Luna, Celsius and FTX imploded in a spectacular manner last year, it was shocking, but not entirely surprising. After all, this is the wild wild west of crypto.
Banks are a different kettle of fish. If you are prudent, conservative and risk averse, then you should probably not gamble with your money at all and stick with the tightly regulated banking industry. The only alternative more vanilla than the good old bank deposit is keeping your money under a mattress, right where you can touch it. But why would you, banks are safe, right?
Over the last couple of weeks a number of banks collapsed, which resulted in governments and regulators having to step in.
In the U.S. it started with Silvergate Bank, which announced its voluntary liquidation on March 8th. Silvergate was one of the key banks in the crypto industry in the U.S., servicing many crypto-businesses, including the infamous FTX. It was after the FTX scandal that many investors chose to withdraw their funds, which together with the broader crypto bear-market ultimately led to Silvergate’s decision to shut-up shop due to looming insolvency. This was sad news for the crypto industry but hardly a surprise given the state of the crypto-market.
The surprising part was still to follow.
Next came Silicon Valley Bank (SVB), which was said to be servicing nearly half of all the VC-backed tech start-ups in America. On March 10th, SVB halted its operations and the regulator, Federal Deposit Insurance Corporation (FDIC) took over the troubled bank.
At the same time, USDC, arguably the most trusted stablecoin, de-pegged from the U.S. dollar and spent half of the day in free fall. As it turned out this was also linked to the troubles at SVB, because Circle (the company behind USDC) had $3.3 billion of its funds in SVB and hence holders started exiting their positions on the fear that Circle will not be able to access its funds. USDC has since regained its peg, after Circle confirmed that most of its reserves are in fact with BNY Mellon.
By March 12th, hot on the heels of SVB, came the news of FDIC taking over and subsequently shutting down the NY based Signature Bank. It too serviced a lot of start-ups around the country and was also one of the very few banks that allowed customers to deposit crypto, in addition to its normal fiat services.
By this point the panic has well and truly set in amongst the start-ups and other affected depositors, unable to access their funds and many questioning how they will make payroll and keep their business afloat. Some people had their personal savings tied up with those banks also. It might also be worth pointing out that SVB and Signature serviced not only U.S. start-ups. They were also popular with international start-ups that had subsidiaries in the U.S.
Finally on Sunday evening, it was announced in a joint statement by FDIC, Department of Treasury and the Federal Reserve that the depositors of SVB and Signature Bank will be protected and will have access to their money. Crisis averted. The following weeks were spent looking for a potential buyer and finally closing a deal with First Citizens bank to take on SVB’s deposits and loans, announced earlier this week.
Meanwhile, as the depositors in the U.S. took a deep breath of relief, across the pond in Europe the clouds were gathering over one of the biggest banks in the world - Credit Suisse. The turbulent week came to a close with the Swiss government having to step in and essentially broker a deal for another mammoth bank, UBS, to buy out the troubled rival for a mere $3.2 billion.
While there were factors specific to each bank’s misfortune, in very simple terms it boiled down to two things - rapidly rising interest rates and a bank run.
Banks generally operate a fractional reserve system, meaning they retain only a proportion of the deposits they receive from customers and lend the rest of the money out. So when a large number of customers withdraw their funds all at the same time, usually over fear of bank’s solvency, a.k.a. a bank run, the bank is not able to fulfill those withdrawals and hence may be forced to default.
In SVB’s case for example, the bank was taking customer funds on short-term deposits and investing them into long-term bonds (making a margin on the difference in rates). This worked while the interest rates were low. But given the rapid rise in rates, short-term rates rose higher than long-term bond yields, meaning SVB started losing money. In order to rectify this problem, SVB announced its plans to raise $2 billion in capital from investors. This spooked the market and SVB’s share price plummeted by 60% following the announcement.
After the rumors of SVB being in financial trouble spread like wildfire around the Silicon Valley, customers (read start-ups) started withdrawing their funds en masse, creating a run on the bank and causing the regulators to interfere.
Silvergate, Signature and Credit Suisse also faced large withdrawals of funds by customers, pushing the banks near or into default territory. Reuters reported that Credit Suisse faced $119 billion of customer withdrawals just in the fourth quarter of last year.
It is important to note that the current banking crisis was not caused by cryptocurrency, but rather was a result of the macroeconomic conditions and their impact on the broader financial system.
“Crypto had nothing to do with the banks’ investment decisions, nor the Fed’s decision to jack up interest rates 19-fold in less than a year,” said Cathie Wood, a prolific crypto-investor and CEO of Ark Invest investment management firm, addressing congressman Tom Emmer in a tweet thread.
There are two opposing views when it comes to the impact of the banking crisis on the crypto industry. On the one hand, with the crypto-friendly banks shutting down, there will be less options for crypto businesses to exist within the traditional financial systems, particularly when it comes to on-ramping and off-ramping (i.e. converting crypto into fiat). The logistics becoming more complex may act as a deterrent for businesses and hence slow the adoption of crypto or at least in the US. Another factor that may slow down the adoption could be that in times of economic uncertainty people tend to flock to safer and more conservative options, in this case likely to be big systemically important banks (JP Morgan, BNY Mellon etc).
The second view is that what the banking crisis showed us is that centralized financial systems are flawed and you cannot rely even on the relatively established banks (SVB was the 20th largest bank in the US). Had the US government not stepped in to rescue these banks, millions of customers would have lost their funds. The proponents of this view believe that the recent events strengthen the argument for decentralized structures and self-custody, and that more people should be looking to digital assets as alternative stores of values. In a nod of agreement, both BTC and ETH prices have been on the rise since the US government announced its rescue package for the troubled banks.
Only time will tell which view will crystallize into reality but for now let’s hope that the last dominos have fallen and this is as far as the contagion will spread.
Liya Dashkina is a VC, contributor to a number of DAOs, web3 consultant, chapter lead at the Australian DeFi Association and an advocate for women in web3.
This article and all the information in it does not constitute financial advice. If you don’t want to invest money or time in Web3, you don’t have to. As always: Do your own research.