Earlier this month, Silvergate Capital gathered its staff to celebrate its transformation into the go-to bank for the crypto market. Then, the crypto market blew up.

The collapse of crypto exchange FTX has raised questions about how close the bank was to the empire of Sam Bankman-Fried. The price of Silvergate’s stock has been cut in half this month and is now down nearly 90% over the past year.

Silvergate has issued multiple statements and pre-announced some results to reassure investors of its stability. It said it had capital to handle withdrawals and had no loans outstanding to FTX or Bankman-Fried. The bank disclosed that its deposits were down, but that volume on its network for crypto investors had risen. It says it still has no losses on bitcoin-backed loans. But the stock has continued to plunge.

“This is a fundamental misunderstanding as to the role that Silvergate plays,” chief executive Alan Lane said on CNBC 18 November.

The market is asking a bigger question: What happens to a bank that has remade itself from a small commercial lender into a middleman of the crypto world if the crypto world collapses?

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On 18 November, crypto-trading platform FalconX told its customers it was no longer using Silvergate. FalconX said the elevated risk in the crypto market required extra caution and told customers its decision was “consistent with other market players.”

“You now have a situation where Silvergate is being viewed as being vulnerable because of the central role it plays within the system,” said BTIG analyst Mark Palmer. Silvergate shares are now trading at levels that imply “a very dire scenario”, he said.

Short bets against Silvergate have doubled this year. It is the second-most heavily shorted regional bank, based on percent of shares outstanding, according to data from S3 Partners. (The most shorted bank has a pending merger, and betting against it is part of an arbitrage strategy.)

Other banks that hold assets for crypto clients, including Signature Bank and Customers Bancorp, haven’t been hit as hard. Signature is down 17% this month, while Customers has fallen 4.5%. Both have a more diverse mix of businesses that are less dependent on crypto companies.

Signature said its exposure to FTX was small, while Customers said it had no exposure. Both said their deposits are stable.

Silvergate is known as an on-ramp to cryptocurrency exchanges. It helps institutional investors move dollars into and out of crypto-trading platforms through its Silvergate Exchange Network, which links the bank accounts of investors and exchanges.

A decade ago, it was a commercial real-estate lender with a handful of branches in the San Diego area. Today, some 90% of its total deposits are tied to cryptocurrency clients. It has shed branches and shrunk its lending book. It doesn’t hold cryptocurrencies, only dollars.

As FTX imploded, investors sold down the bank’s stock, worried about deposits fleeing.

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Silvergate said that it only held FTX deposits and that it had no other lending or investment exposures. It said it now has $9.8bn in digital deposits, down by $2.2bn, including removing all of the FTX deposits, since the end of the third quarter.

FTX held some deposits at Silvergate in what is known as an omnibus account — meaning the assets belonged to FTX customers. It was FTX’s responsibility to keep a ledger tracking the underlying customer assets, a common setup for firms that aren’t banks themselves.

The Wall Street Journal has reported FTX used customer assets to help fund its related trading operation, Alameda Research. Short sellers on Twitter and social media have asked questions about what Silvergate could have seen or should have flagged about movements between the two.

Silvergate wouldn’t have had visibility into the omnibus account to know whether FTX or its underlying customers were moving assets, people familiar with the relationship said. FTX has halted withdrawals, and Silvergate has told customers it cannot take direct requests to withdraw from the FTX accounts. Bank monitoring looks for transactions that fall outside a client’s expected patterns, which could be complicated by FTX and Alameda’s wide overlap.

Even if the FTX deposits do all leave, the bank says it is structured to protect itself from huge outflows. It holds almost all its assets in highly liquid securities such as Treasurys, which it says can be quickly sold or borrowed against.

“No bank in the world can honour every deposit held on its balance sheet with cash, although Silvergate might be the closest, in our view,” KBW analyst Michael Perito wrote.

Silvergate had other plans for this month. It had gathered all its staff in California for the first time since the pandemic, people familiar with the bank said. On 7 November, it announced it had promoted Ben Reynolds, its crypto-industry point man, to president. It also named a new chief risk officer.

Instead of celebrating, executives found themselves answering calls and watching rumours swirl on Twitter about a potential run on the bank, the people said. They focused on making sure the network was working properly.

Average daily volume on the network has risen to $1.9bn so far this quarter from $1.2bn last quarter, the bank said.

“After [third-quarter] earnings, we posed the question: ‘Is the worst behind them?'” Bank of America analysts wrote in downgrading the stock. “We were wrong.”

Write to David Benoit at David.Benoit@wsj.com

This article was published by The Wall Street Journal, part of Dow Jones 

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