SVB Collapse: The Impact to the Crypto Market

You may already be aware of Silicon Valley Bank's demise, which ranks as the second-largest bank failure in American history and the biggest since the 2008 financial crisis. After a bank run that sapped the corporation of funds on Friday, regulators intervened to seize control of the bank.

The fall of Silicon Valley Bank will have an impact on the whole IT sector, but its impacts are already being seen in the cryptocurrency markets. The second-largest stablecoin, USDC, has failed to regain its $1 peg as of the publication of this article. It once dropped as low as $0.89. CoinDesk notes that USDC dropped far more than it did even after the demise of the cryptocurrency exchange FTX [1].

Just read this statement, “the fifth largest cryptocurrency by market value lost its dollar peg after its issuer announced that it had around 8.25% of its $40 billion reserves locked in failed Silicon Valley Bank” [1]. Sounds like quite a big statement right? So who is SVB? What actually happened? How did they get it wrong? Is moral hazard at play? And what are the wider ramifications to the crypto market? Let's take a closer look and examine what happened.

The Background

On March 8, SVB (NASDAQ:SIVB) published an 8-k in which it disclosed that it had lost $1.8 billion and liquidated $21 billion of its AFS portfolio. The bank intends to seek $2.25 billion in stock capital to make up the difference. Nonetheless, this decision was poor considering the leverage ratio of 13.0x. The $91 billion Held-To-Maturity securities portfolio was not marked to market, which led the market to immediately conclude that the value of SVB's assets would be much lower than their reported book value and that the bank might really be insolvent.

The market value of the SVB fell by 85% over the course of two days, resulting in a trading stop on March 10 morning. The FDIC then put the business into receivership and took over management of SVB's assets and business activities.

Who is Silicon Valley Bank (SVB)?

Silicon Valley Bank (SVB), a prominent lender to the technology industry, was shut down by federal regulators Friday in one of the largest bank failures in U.S. history, sending shudders throughout the industry [2]. The Santa Clara, California-based organization was established in 1983 and offered banking services and accepted deposits for tech giants, venture capital companies, and startups in Silicon Valley.

The bank, however unremarkable by Silicon Valley's customary standards and little-known outside of business circles, was crucial in assisting the tech industry through its most recent valuation boom.

“SVB offers financial and banking services to help, as you capitalize on business opportunities, raise capital, protect equity, manage cash flows and access global markets,” a message on the bank’s website says.

The bank had $209 billion in assets as of Dec. 31, 2022. SVB’s collapse is the second-largest bank failure in history, trailing only that of Washington Mutual Inc., and the largest of its kind since the 2008 financial crisis [3]. Notable firms listed as SVB customers include Pinterest, ZipRecruiter and Shopify.

Traditional banking was the most evident service provided by SVB. It provided the standard checking accounts, credit cards, and money market accounts with yields of up to 4.5% a year.?

While Silicon Valley Bank made risky investments, what really appears to have harmed the bank was the pandemic. Or, really, what it did due to the tech sector's success during the early days of the pandemic.

In 2020, the IT sector thrived despite the global quarantines and lockdowns. The majority of time was being spent in front of computers or working remotely. Tech firms made a lot of hires, and several startups secured finance. With client deposits totaling $60 billion at the conclusion of the first quarter of that year, Silicon Valley Bank. Silicon Valley bank had a total of around $200 billion in client deposits at the end of the first quarter of 2022.

Why do banks fail?

Let's talk about why banks fail before we analyze SVB's demise. Banks collapse because their deposits are short-term while their loans are long-term. This means that although banks may simply call back their short-term deposits, they cannot readily do so with their long-term loans. Everything is alright as long as depositors don't rush to the bank to make their deposits.

Yet, depositors may hastily remove their money in the event of an economic or financial crisis or if there are questions about a bank's asset profile. Every bank, whether it is healthy or not, will inevitably fail if it occurs. As we witnessed in the instance of SVB Bank, rumors may even start bank runs and force them to fail. This is how banking operates.

How did SVB get here?

What transpired to SVB, then? We need to go back to the beginning of 2020, when the COVID-crisis caused an extraordinary cash flood, to get the answer. The Fed put that caused this cash flow also caused a surge in venture capital activity.

The Silicon Valley Bank, which has established itself as the bank for the venture capital industry, benefited from an influx of deposits against the backdrop of a risk-on mindset that flooded start-ups and founders with cash. The total SVB deposits actually increased by more than three times between 2019 and late 2022, from $61.7 billion in 2019 to $173 billion as of December 2022.

What should SVB do with these deposits at this point? Writing loans was not particularly appealing due to a depressed NIM spread (another effect of QE). SVB made the decision to store the extra cash in US Treasury securities and other low-yield risk-free notes. Although these instruments were seen as "risk free," they rapidly declined as interest rates rose after the conclusion of QE and the beginning of QT. (Note that the value/ price of a bond is inversely connected to the interest rate level) [6].

Silicon Valley Bank made the decision to do something with all of this fresh money. Thus, the corporation made investments in mortgage-backed securities and Treasury bonds. The Federal Reserve then increased interest rates in an effort to combat the United States' increasing inflation. Ultimately, Silicon Valley Bank was impacted in a number of ways. One is that the value of the bonds it purchased decreased. The tech sector has to readjust as a result of the cost of borrowing money due to increasing interest rates. Moreover aggravating the issue, venture capital funding began to decrease as VCs withdrew from tech ventures. Silicon Valley Bank sold off some of its assets for a $1.8 billion loss in order to reduce its losses.

SVB had to contend with declining fixed income security prices all of a sudden. Savings were leaving the banking system because they preferred to find higher yielding alternatives to keeping their money in a bank, which added to worries about a declining asset base. A balance sheet squeeze was approaching. However, the crisis happened swiftly when the market became aware of SVB's difficulties.

So the atmosphere of rising interest rates is where the downfall of SVB began. Several SVB clients began withdrawing money as increasing interest rates forced the market for initial public offerings for many companies to close and increased the cost of private financing.

SVB announced on Wednesday that it will sell $2.25 billion in common equity and preferred convertible shares to close the financing gap after selling a $21 billion bond portfolio made up primarily of US Treasury bonds to pay for the redemptions. Depositors began to fear as its stock fell. Last week, SVB struggled to ensure its venture capital customers that their funds were secure. On Friday, the falling stock price had rendered the capital raising unworkable. According to sources, the bank sought to explore other options, such as a sale, before regulators intervened and closed the business [4].

Explaining the Situation in ‘Layman Terms’

Lets try to unpack this situation in simple language through an example. SVB could be viewed as a bank of startups and hence people referred to it as the ‘Bank of Crypto’ and it turned out that the bank had made a huge concentrated bet on interest rates. Their customers were flush with cash and they deposited with the bank they did not need loans.

So instead, the bak invested all that cash in longer dated fixed-income securities, which lost value when the interest rats went up, which lost value as rates went up. But as the interest rates went up, customers also got impacted as it turned out that they were impacted by higher interest rates, and in a higher-interest-rate environment they did not have enough money anymore. So they withdrew their deposits and the bank had to sell their securities at a loss to pay them back.

Now the bank has lost money and appeared financially unstable, so customers got spooked and withdrew even more money which lead to the selling of more securities, so the bank ended up booking more losses.

Is Crypto to blame?

For once, it didn't appear like crypto was at the center of the situation. Friday's abrupt collapse of Silicon Valley Bank caused alarm throughout the technology sector. Nonetheless, crypto executives and investors who have suffered through a year of almost nonstop upheaval, seized the opportunity to lecture and chastise.

Regarding cryptocurrencies, it's possible that recent setbacks in the sector contributed to the prevailing conditions that caused this bank run. Another bank that mostly catered to the IT industry failed just before Silicon Valley Bank. Silvergate Bank stated on March 8 that it will shut and sell its assets. In the cryptocurrency business, Silvergate was particularly well-known for being one of the most client-friendly banking organizations [7].

But, Silicon Valley Bank's repercussions are also being felt by the cryptocurrency industry. In actuality, that is the reason why USDC is now trading for a significant discount to its $1 peg. The stablecoin's creator, Circle, said that it had $3.3 billion in deposits at Silicon Valley Bank. According to CoinDesk, this represents about 8% of the reserves supporting the USDC stablecoin.

These crypto holders are paying more fees as individuals try to exchange their USDC for other stablecoins. The gas prices connected with the transactions have significantly increased as a result of the excessive use of the Ethereum network to make these transfers.

The crypto enthusiasts blamed centralized banks. Their idea of a different financial structure that wasn't dependent on large banks and other gatekeepers was superior. They said that the recent crackdown by government officials on cryptocurrency businesses had sowed the seeds for the collapse of the bank.

The proponent of Bitcoin, Erik Voorhees, used the colloquial term for conventional currencies, "Fiat," in a blog post for underlying cause for why the SVB collapse took place (alongside poor risk management).

The machine is experiencing problems, according to Mo Shaikh, CEO of the cryptocurrency business Aptos Labs. "This is a chance to pause and think about the realities of decentralization." [5]?

The mood immediately changed, however, when a significant cryptocurrency corporation disclosed late on Friday that it had billions of dollars stashed away in Silicon Valley Bank. Market tremors were caused by the unexpected price drop of a so-called stablecoin intended to keep the value of one dollar constant.

Then there was pointing of the fingers in opposite directions. Several tech investors suggested that the Silicon Valley Bank crisis was caused by the bad actors and overnight collapses that plagued the cryptocurrency realm, which trained individuals to panic at the first hint of difficulty. Sam Bankman-Fried's cryptocurrency exchange, FTX, shut down in November after a crypto-equivalent of a bank run revealed a sizable vacuum in its financial records.

In the IT sector, where hot start-ups and trends come and go and crises may be utilized to further agendas, the blame game is an indication of factionalism. Crypto proponents accused the old banking system's architecture for creating instability when Silicon Valley Bank collapsed. Several speculative investors attributed the bank run to social media hysteria. Others criticized the bank itself for bad management and poorer communication, or the government for its economic policies.

Silicon Valley Bank appears to have had a relatively small footprint in the crypto industry. Historically, many large banks have resisted working with crypto companies, given the legal uncertainty surrounding much of the business [5].

Yet, as the crisis grew, proponents of cryptocurrency saw the demise of Silicon Valley Bank as an opportunity to advance the points they had been making ever before the 2008 banking crisis. That said that turbulence demonstrated how centralized banking institutions were, which served as motivation for the invention of Bitcoin.

What will be the impact of SVB’s failure on US and global financial markets?

Every time a bank collapses, there is a strong likelihood that other banks will follow. As a result, we saw a decline in bank shares as a result of SVB's collapse. In fact, because banks are essentially the backbone of the financial system, it also caused a downturn in stock markets worldwide, not just in the US.

The comments have been compared to Lehman Brothers' collapse, which caused the Global Financial Crisis. In regard to the Lehman crisis, there are both parallels and contrasts. The parallelism lies in the fact that both the Lehman and the SVB crises emerged following a protracted period of cheap credit. The difference is that because Lehman was a considerably larger international investment bank, its demise had more significant worldwide effects.

Regulators have tightened the financial sector after Lehman and the GFC. Yet nothing is impregnable. More worries about a worldwide recession will surface if the market collapse persists.

What about moral hazard?

The possibility that a party did not enter into a contract in good faith or gave false information regarding its assets, obligations, or credit capacity is known as moral hazard. Moral hazard may also refer to a party's incentive to take exceptional risks in an effort to benefit before the contract is settled.

When a person or institution knows that someone else will be held accountable for their conduct, moral hazard refers to the belief that they may take on greater risk than they otherwise would. When banks are aware that they will be saved by the government or central bank if they fail, moral hazard can occur in the financial context. As a result of knowing that the government will step in to save them if things go wrong, banks may end up taking on more risk than they otherwise would.

With the failure of SVB, the ramifications of moral hazard could include:

1. Encouraging Risk-Taking: Knowing that they will be bailed out if they fail, banks may take on more risk than they would otherwise. This can lead to a situation where banks are encouraged to engage in risky behavior, which can ultimately lead to another financial crisis.
2. Increased Costs to Taxpayers: If the government or central bank bails out a failed bank, it can be costly for taxpayers. This can lead to increased public debt, higher taxes, and reduced government spending in other areas.
3. Decreased Confidence in the Financial System: If banks are bailed out repeatedly, it can erode public confidence in the financial system. This can lead to a loss of trust in banks and other financial institutions, which can have long-lasting effects on the economy.
4. Unfair Advantage for Large Banks: Knowing that they will be bailed out if they fail, larger banks may have an unfair advantage over smaller banks that do not have access to government bailouts. This can lead to consolidation in the banking industry, reducing competition and potentially leading to monopolistic practices.

Larger bank clients will undoubtedly feel more at ease knowing they may place their money with whatever institution is prepared to provide them the best conditions after seeing depositors being made whole in the current situation. It acts as a deterrent to responsible behavior on the part of banks and depositors. Customers of SVB who used extra caution when banking are not being rewarded here. Politicians and economists would claim that if there had been a financial crisis, society as a whole would have fared far worse. But what will happen when something similar fails again, especially if it is worse than SVB? Then, who will foot the bill for an all-encompassing emergency guarantee on uninsured deposits?

How to strike a balance among a number of important hazards in the SVB's resolution process is the current dilemma facing policymakers. Making all depositors whole with regard to the funds they have with SVB comes with a moral hazard risk, which is the first concern. If not, officials must take into account the susceptibility of other small and regional banks to deposit losses as well as the effects on the US and global startup environment.

What about the impact to stablecoins such as USDC?

The failure of the US-based Silicon Valley Bank (SVB) has caused a crisis in the stablecoin market. Around 8% of the reserves of the second-largest stablecoin, USDC, are held by the US financial institution, which led to panic in the crypto markets over the weekend [8].

Customers withdrew billions from Circle's USDC stablecoin on the previous day, causing the coin's price to plunge below $0.87 early on Saturday morning and its market cap to tumble from $43.5 billion to $37 billion. The second-largest stablecoin in terms of market cap behind Tether, which has a market worth of $72 billion, is 2 USDC [9].

The value of USD Coin (USDC) plummeted to an all-time low on Saturday when Circle, the US company that created the coin, disclosed that Silicon Valley Bank was the location of $3.3 billion in reserves that were used to support it.

Designed to maintain a steady value, USDC is a stablecoin whose value is meant to resemble the US dollar. Yet on Saturday morning, the currency dropped as low as $0.87 after breaking its 1:1 dollar peg.

With a market valuation of $40 billion, USD Coin (USDC) has established itself as the main foundation currency for DeFi apps. The stablecoin is recognized as having the finest regulation and is issued by American institution Circle Financial. The USDC reserves are kept in sizable banks, and Deloitte, one of the "Big Four" auditors, conducts a thorough audit of them every year. However, it was this high level of compliance that ultimately proved to be a problem, causing the market to de-peg stablecoins worth billions of dollars.

According to Circle's website, USDC is completely collateralized with a mix of cash and US Treasuries. In particular, USDC is 23% (9.7 billion USD) in cash kept at a variety of institutions and 77% (32.4 billion USD) in US Treasury notes (with a maturity of three months or less). The Treasury securities are kept at BNY Mellon, and BlackRock is in charge of active liquidity and asset management. The custody of the money is where the problem lies [8].

With the $40 billion collapse of the TerraUSD stablecoin in May of last year, the stablecoin industry has been the subject of increasing regulatory investigation. The most recent unrest increases the level of uncertainty for bitcoin investors and will amplify the cries for more regulation. In light of the failure of Silicon Valley Bank, Federal Reserve Chairman Jerome Powell's remarks this week that he sees "turmoil" and "run risk" in digital currencies haven't aged well.

Final Remarks

In summary and in simple terms, the FT have stated that the fragility of SVB came from the perfect storm undermining both its balance sheet and liquidity. Specifically, it was exposed by the mix of a concentrated deposit base and the eroding of the market value of the safe assets that partially offset this liability [10].

The SVB collapse just highlights the insanity of our entire financial sector. The panic over a wider contagion is based on the fact that everyone knows the entire fraction reserve banking system is a house of cards that can collapse at any time.

This was the result of a very large deposit growth and investing in bonds. Regulators were asleep and investors were not reading the financial statements it published quarterly. Large depositors were not watching the terrible decisions made by management, either.

Yet, as the crisis grew, proponents of cryptocurrency saw the demise of Silicon Valley Bank as an opportunity to advance the points they had been making ever before the 2008 banking crisis. That said that turbulence demonstrated how centralized banking institutions were, which served as motivation for the invention of Bitcoin.

Also, the SVB is a single bank. Yet, commercial bank deposits total $18 trillion throughout the whole banking sector. Just $10 trillion of these are insured. If I were one of the depositors with a portion of the $8 trillion in uninsured deposits, I would leave immediately, withdrawing my funds on Monday and investing them in a money market fund that invests in other safer assets. As a result, uninsured borrowers may launch a major, immediate run on banks, which the Fed and Treasury have recently shown they are powerless to halt.

Citations:

[1] https://www.thestreet.com/technology/svb-collapse-rocks-crypto-stablecoin-usdc-loses-its-dollar-peg?

[2] https://www.investopedia.com/silicon-valley-bank-fails-insured-deposits-to-be-protected-7253956#:~:text=Silicon%20Valley%20Bank%20(SBV)%2C,sending%20shudders%20throughout%20the%20industry.?

[3] https://nypost.com/2023/03/10/what-is-silicon-valley-bank-and-why-did-it-suddenly-collapse/?

[4] https://gulfnews.com/business/banking/silicon-valley-bank-is-largest-failure-since-2008-crisis-billions-stranded-1.94387340?

[5] https://www.nytimes.com/2023/03/11/technology/silicon-valley-bank-crypto-investing.html?

[6] https://seekingalpha.com/article/4586743-svb-financial-collapse-explained?

[7] https://me.mashable.com/tech/25983/silicon-valley-bank-explained-how-crypto-is-being-affected?

[8] https://cvj.ch/en/hot-topics/news/svb-bankruptcy-leads-to-de-pegging-of-usdc-stablecoin/

[9] https://www.investopedia.com/usdc-loses-peg-7254222

[10] https://www.ft.com/content/5a723f25-0dd3-4cff-b511-b01d7467a4ba