The entire Silvergate Situation explained and why the Fiasco is so fascinating. How they lost $1 Billion, and how [SERIOUS] the risk is for Silvergate is to fail.

First off, let us make clear what Silvergate it. Silvergate is, by all accounts, a bank i.e., they accept deposits from customers and use the deposits for loans to other customers. Of course however, they accept cryptocurrency deposits and although they only allow lend USD-denominated loans that that backed by Bitcoin collateral. They also allow customers to transfer funds to each other just like a bank does.

Now, we need to establish a base. In 2021,Silvergate reported 1,381 customers on the platform, an increase of more than 400 from 2020. Additionally, SEN transfers totaled $787.4 billion, up significantly from $135.7 billion in 2020. So 2021, was a good year. We know and remember this from the 2021 bull run.

Now for 2022, there are some hiccups. And these hiccups lead up to where we are now. Silvergate has recently stated it would not be able to file its annual report with the Securities and Exchange Commission on time. The report specified is actually for 2022, as the actual report is typically released a several weeks after the actual timeframe in question as accounting simply takes a fair bit of time. But why would Silvergate miss their deadline. Well this is where it gets really interesting.

Remember, for 2022, i said there were hiccups. Well, firstly, we don't have an annual report for 2022. But we do have quarterly reports for all four quarters. Here's what it reveals.

Skipping some accounting stuff, Silvergate has experienced consistent and significant growth throughout 2022.

[Their amount of customers increased by 15% and 6.6% between Q1-Q2 and Q2-Q3 respectively. Net income increased 64% or $15.1 Million and 14% or $5.3 Million between Q1-Q2 and Q2-Q3 respectively. ]

But Q4 was...bad. Silvergate took a loss of 1 Billion in Q4 and lose 3.3% of customers. They profited only 43.3 Million the prior quarter of Q3 but lost 1 Billion in Q4.

But why did they lose so much? Well, remember what happened in Q4. The whole FTX saga? Technically, Bitcoin "only" lost 20% of its value in Q4 due to that saga. Silvergate had 1.5 Billion in BTC-backed loans in Q3. Assuming an 100% or more collateral ratio, which is very common in crypto, this means that Silvergate should have only lost $300M on the BTC collateral. Then, Silvergate reported having to sell $718M in assets at a loss to allow 8.1 Billion in withdrawals in the wake of the FTX collapse. Thus, we come to $1B loss, through collateral losses and assets sales.

At the end of Q4 their loans dropped from 1.5 Billion to 1.1 Billion and some customers almost definitely defaulted. In the worst case, Silvergate had $400M in forced liquidations, but from which they held onto the BTC collateral.

But here's the really fun part.

Whatever losses Silvergate took on customer default, they held onto the collateral. Since the beginning of this year 2023, Silvergate BTC collateral has increased 30%. This means that Silvergate would be in significant profit of 30% of more on a few hundred million up the presumed worst case $400M BTC collateral from liquidations. And this profit is not reflected in the Q4 2022 financial report. The extra $700M or so should be covered due the the previously reported assets in Q3 Additionally, typically the largest expense of a business is employee wages, and 40$ of staff was cut in January. The financial statement reports that ~50% of their expenses was due to "Employee Salaries and Benefits". Again, these savings would not be reflected in the Q4 2022 report. They also yesterday reported cutting the SEN Exchange network, which allowed customers to transfer deposit funds to each other, which was probably a non-performing asset anyway as customers could simply use native crypto networks to transfer without paying Silvergate fees. This lowers Silvergate costs even further.

If you want to argue that they over-hired, they already cut 40% of stuff to reduce costs. If you argue on their loan losses, that those have already been erased as BTC bounced back. If you want to argue their loss of deposits and customers, their losses and amount of customers, their deposits and customers are FAR higher than it was the previous year even after accounting for those related losses they faced in 2022. Basically, 2023 is much healthier than 2022 Q4 Silvergate.

Severely underestimating the recovery Silvergate made from their BTC collateral, and assuming the only broke-even on the $300M loss, Silvergate should have had somewhere around at least $1.2 Billion in assets that allowed them to absorb the excess $731 Million in losses from their asset sale. Thus, discarding customer deposit, their worst case should leave them with around $400 M in free fully-owned assets to date, even after accounting for the ~1.4% losses on their morgage backed securities, which accounts for about half their assets.

However, the make or break is that very recently a number of big exchanges have scaled back operations with Silvergate in the wake of these fears, which would reduce their deposits. To cover withdrawals $8B in withdrawals, they were forced to sell assets at a 14% loss. If there is another bank run, Silvergate would have very little free cash and assets left, to the tune of a few dozen to maybe a few hundred million, which is essentially almost nothing.

But even then, Silvergate still has the option of going into debt to keep the business running, and use profits to pay off this debt over time. There won't be the largest pool of willing lenders, but banks are extraordinarily well-connected to obtain credit/to borrow, especially for just a few hundred million, a pittance for large financers, which will be all Silvergate needs to weather through. They also still have the option of raising collateral requirements on current borrowers.

TLDR: Outside of actual and large-scale financial misconduct/fraud, nothing shows Silvergate is likely to surely fail, but they are certainly heavily stressed. They should be in, a worst case, a small profit or more likely in huge profit from early 2023 gains on loan collateral from any borrowers that failed to repay. They have already cut 40% in employees that amount to half their expenses. And between their high total loans, healthy loan-to-deposit ratio and dynamically adjusting their collateral ratio on borrowers, and the option of going into debt, it in unlikely for them to fail.

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https://www.theguardian.com/technology/2023/jan/05/silvergate-forced-to-cover-8bn-worth-of-crypto-related-withdrawals

https://ir.silvergate.com/news/news-details/2023/Silvergate-Capital-Corporation-Announces-Fourth-Quarter-2022-Results/default.aspx