Washington’s watchful eye doesn’t like what it sees across the crypto industry ecosystem.
This, as U.S. prosecutors in the Department of Justice’s (DOJ) fraud unit are reportedly examining Silvergate Capital’s banking relationship with the collapsed crypto giants FTX and Alameda Research.
The DOJ probe, which is already underway, does not accuse the bank of any wrongdoing.
As reported by PYMNTS, the federal investigation comes about two months after U.S. senators Elizabeth Warren (D-Mass.), John Kennedy (R-La.) and Roger Marshall (R-KS) penned a strongly worded Dec. 5 letter to Silvergate requesting answers around the bank’s role in “facilitating the transfer of FTX customer funds to Alameda.”
The bank’s response did little to quell the senators’ questions.
“We are disappointed by your evasive and incomplete response to our December 5, 2022 letter,” the trio of lawmakers wrote in a new note to Silvergate made public earlier this week (Jan. 30).
“We wrote to you seeking information on what appeared to be an egregious failure of your bank’s responsibilities to monitor and report suspicious financial activity. Your response confirms the extent of this failure — but then neglects to provide key information needed by Congress to understand why and how these failures occurred,” the senators added. “Both Congress and the public need and deserve the information necessary to understand Silvergate’s role in FTX’s fraudulent collapse, particularly given the fact that Silvergate turned to the Federal Home Loan Bank as its lender of last resort in 2022.”
Silvergate modeled itself as one of the leading go-to banks for crypto companies and emerged early on as a key provider of services catering to the industry.
It built industry-specific systems that allowed real-time fiat currency transactions between cryptocurrency customers with deposits at the bank, which included FTX founder Bankman-Fried’s enterprise group of cryptocurrency companies.
Alameda Research, for example, opened an account with Silvergate in 2018, a year prior to the 2019 founding of the FTX exchange.
As such, it was among the more traditional lenders hit hardest by FTX and Alameda’s rapid implosion last November — reporting a $1 billion loss for the final quarter of 2022 and undertook a 40% reduction in headcount.
Silvergate has repeatedly emphasized that it is reviewing transactions involving accounts associated with FTX and Alameda.
For its part, the bank claims that it conducted due diligence on FTX and Alameda during the onboarding process and that it is presently undertaking an ongoing investigation of transactions linked to Bankman-Fried’s failed enterprise. Silvergate is subject to annual exams by the Federal Reserve as well as independent audits.
In response to these claims, the letter from Senators Warren, Kennedy, and Marshall reads, “[These claims] reveal that Silvergate had risk management and due diligence processes in place – but that they did, in fact, fail miserably. They reveal that neither the Federal Reserve nor Silvergate’s independent auditors were able to identify what we now know were extraordinary gaps in Silvergate’s due diligence process.”
Per the letter, Silvergate makes repeated reference to “confidential supervisory information” as a justification for refusal to provide the information requested. “This is simply not an acceptable rational,” the senators say.
A critical reason behind both the DOJ probe and the hard-hitting lawmaker letters, beyond just the many questions over its FTX relationship, is that, as reported by PYMNTS, Silvergate took out billions in short-term Federal Home Loan Bank (FHLB) advances as it sank further into distress to boost its balance sheet in the case of further adverse events stemming from crypto market volatility.
“By using the FHLB as its functional ‘lender of last resort,’ Silvergate has further introduced crypto market risk into the traditional banking system. If Silvergate were to fail — as have banks facing a fraction of the withdrawal rates Silvergate has faced — it could leave the FDIC — and therefore the American taxpayer — holding the bag,” write the senators.
A publicly traded company, Silvergate’s 52-week range of a $162 high compared to its $10 low shows just how severely the lender’s entanglement in the crypto sector has affected investor confidence.
Silvergate’s share price is down around 87% year over year, and as of writing (Feb. 3) is trading around $17 off the news of the federal probe.
Perhaps smelling a deal, traditional financial institutions State Street, the second-oldest continually operating bank in the U.S., and BlackRock, the world’s largest asset manager, have both increased their holdings in Silvergate per recent regulatory filings.
State Street reported a 9.32% passive stake, while according to a Jan. 31 filing with the Securities and Exchange Commission (SEC), BlackRock has recently increased its holding in Silvergate to 7.2%, an increase from the 5.9% it previously held.
Regulatory approval is not required for ownership stakes below 10%.
The disclosures come as Silvergate seeks to ease investor concerns over its future and mollify federal scrutiny.
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