The collapse of multiple crypto-friendly US banks is sending DeFi companies in search of global options, but unfair policies are only masking systemic issues in traditional finance.
Ever since I got involved in blockchain more than seven years ago, access to banking services for crypto businesses has always been one of the big pain points in the industry. Here in Canada, colleagues have not only faced challenges in obtaining bank accounts for their mining and exchange businesses, but frequently been denied personal account services – extending even to their spouses.
The rise of publicly-traded DeFi businesses, crypto ETFs, and greater integration with traditional finance has moved the dial a little. However, denial of services, or the charging of massive fees to compensate for exaggerated risks, is still widespread. Relative to Canada, US banks have been more innovative and open to DeFi – but the recent collapse of four leading service providers to blockchain companies has sent shockwaves through the industry.
The collapse of FTX dramatically – and unfairly – changed the risk profile of the crypto sector to regulators and financial institutions. Despite a growing awareness that the exchange’s multi-billion-dollar collapse was primarily caused by massive failures of accountability and governance, DeFi markets have been targeted for what US Blockchain Association CEO Kristen Smith described as a “crypto carpet bombing”.
According to expert bankruptcy attorney John Ray III, appointed as FTX CEO late last year after a long list of similar roles in firms like Enron, “Never before in my career have I seen such a complete failure of corporate controls.” The underlying technologies and asset types were not the main driver of FTX’s failure – it was bad business practices hidden by Sam Bankman-Fried’s close relationship with the SEC.
“Silvergate Capital, another popular bank and lender for crypto companies, had also suffered major losses due to risky business practices – echoing SVB, the bank was at risk for liquidity issues due to relying heavily on volatile, short-term deposits while having too much capital tied up in low-yield, long-term investments.”
Scapegoating cryptocurrency only masked the real issues behind FTX – many of which, like unsound investments, corruption, and poor governance, are frequent problems across all industries. Similarly, the recent fall of Silicon Valley Bank (SVB), which did business with almost half of all venture-backed tech companies in the country, has led to another round of blaming cryptocurrency for problems that ultimately, have little to do with the digital economy.
A popular choice for start-ups and disruptive technology businesses, SVB had US $212 billion in assets in March when rumours about its shaky foundations caused a run by depositors, most of whom exceeded the US $250,000 eligible for insurance by the federal government. The resulting liquidity crisis happened because SVB – certain that interest rates would stay at record low levels – had tied up massive amounts of capital in very low-yield government bonds, which it had to sell at a steep discount in the market.
Silvergate Capital, another popular bank and lender for crypto companies, had also suffered major losses due to risky business practices – echoing SVB, the bank was at risk for liquidity issues due to relying heavily on volatile, short-term deposits while having too much capital tied up in low-yield, long-term investments. In early March, the bank announced it would be unwinding its operations, and undertaking an “orderly dissolution.”
The even-larger Signature Bank, with 20% of its more than US $100 billion in deposits from crypto companies, was recently seized by regulators in a move that shocked board members like former US Representative Barney Frank. Despite that concerns about the bank’s solvency were due to its major stakes in rent-controlled New York real estate, Frank said in a statement to Bloomberg Radio that the seizure was “to send a message to get people away from crypto,” with Signature as the “poster child” for that message – and that it was known, but unacknowledged by the FDIC, that any buyer for Signature would have to eschew crypto.
It’s a clear attack on the crypto sector hidden under the guise of “risk management”. But where are the real risks? The dangers for SVB and Silvergate were in overweighting seemingly safe government bonds, and Signature took big stakes in unprofitable real estate. These were all bad business decisions exacerbated by inflation and rising interest rates – and being used as excuses to crush cryptocurrency.
Now, crypto businesses are searching for options in Europe, including traditionally friendly countries like Switzerland. However, the shocking collapse of Credit Suisse and its fire-sale to UBS highlights the risks of the banking industry to crypto, even in the safest of jurisdictions.
Credit Suisse, which made a string of large and speculative investments in fraudulent companies and permitted hedge fund borrowers to take “catastrophic risks”, once denied Cardano founder Charles Hoskinson a bank account because crypto was “too dangerous”.
High interest rate environments reveal all kinds of fragilities in economies, and it’s clear that in the US, crypto is being used as a scapegoat to hide bad decisions – and in Europe, despite the terrible investments made by Credit Suisse and others, banks are being ordered to single out crypto for one of the highest possible risk ratings.
Many parts of the world are on the verge of a recession. According to leading economist Nouriel Roubini, inflationary pressures mean that the kinds of bailouts that propped up the economy during the pandemic are no longer possible, and high leverage, lower wages, and declining asset values are a “Bermuda Triangle” of risk factors globally.
Attacking crypto – a relatively small US $1 trillion market – has no power to meaningfully reduce banking risks, which result from economic conditions exacerbated by poor decision making, and “tiny buffers” that make institutions fragile to inflation. Fears about providing services to crypto companies are misdirected, especially in jurisdictions like Canada that are heavily regulated.
What will the future look like? Most likely, affected companies will simply shift to regions like MENA, which are actively cultivating strong digital economies, like Dubai’s push to build a blockchain-based economy. Personally, I agree with crypto like Bitcoin being the solution to, not the cause of, failures of centralized finance, and I predict a much greater role for DeFi if a recession takes hold, as people around the world demand more control over their own economic destiny.