Notes 3/2: Silvergate Bank, MakerDAO’s Terra Transformation

Shares for Silvergate Capital, the entity that owns a bank that services the cryptocurrency ecosystem, crashed by more than 40% after it announced a delay in filing its annual report.

The company also said it was “analyzing certain regulatory and other inquiries and investigations that are pending,” suggesting that it may have been caught in the crosshairs of an ongoing crypto crackdown by regulators.

Silvergate, which used to be a community bank in San Diego, derives the bulk of its business from companies operating in the crypto ecosystem. They have imploded or deserted the bank since last year amid revelations that crypto exchange Binance’s US subsidiary, another Silvergate customer, was used to move funds to a market maker for its global operations.    

Silvergate: Another Crypto Casualty?

Hardly. While most banks and financial institutions stayed away from cryptocurrencies to avoid tarnishing their brand and protect their balance sheets from the sector’s volatility, Silvergate embraced the industry. That association has transformed its fortunes.

In 2013, the community bank reported net income of $1.4 million, the fourth highest quarterly profit in its 25-year history. By the third quarter of 2022, it was reporting quarterly profits of $40.6 million. It had deposits of $13.9 billion in deposits at the beginning of last November and crypto customers were responsible for 86% of the total. Silvergate Capital also became a publicly listed entity in 2019, offering shares to the public for cash to grow its cryptocurrency business.

Cryptocurrencies have powered Silvergate’s business transformation. The company’s product – the Silvergate Exchange Network (SEN) solution – is a platform that facilitates crypto trading by enabling institutional customers to move dollars between cryptocurrency businesses and exchanges. The wrapping of a financial services institution for the solution helps them to cash out in US dollars quickly.   

Interest Income and Crypto Downturns

In the SEN arrangement, cryptocurrency businesses deposit cash at Silvergate to enable fiat withdrawals for their customers. The deposits are interest free, and the bank can do whatever it wants with them to generate yield.

Silvergate invested those deposits into treasuries. They generated good yields. At the end of the third quarter of 2022, the company’s interest income had skyrocketed to $90.7 million from $37.9 million. Securities contributed 68.1% of the total figure.   

In a high interest rate environment, Silvergate’s investments in Treasuries turned out to be a fortuitous one. While it did not provide a figure for the yield from those assets, it claims that those investments helped it withstand withdrawals of more than 70% of its deposits last quarter. The company said it had sold $5.2 billion of debt to service customers in the final quarter of last year. It also said it realized losses of $718 million by selling some of its treasuries before their maturity dates.

But it is unclear whether there was actually a run on deposits from crypto customers. According to its own filings, the company’s digital asset customer count dropped only marginally from 1,677 to 1,629.

A Takeover Target

A JP Morgan analyst stated in a note yesterday that the company is facing significant regulatory and business challenges stemming from its exposure to cryptocurrencies and was “reevaluating its businesses and strategies.”

He is on the wrong track. If anything, the bank seems to have doubled down on the digital assets operations.

During the company’s latest investor call, Silvergate CEO Alan Lane even suggested that the company might be an ideal takeover target for larger institutions.

“At some point in the future, it is quite likely that a larger institution that wants to get into the [cryptocurrency] space will want to take a look at Silvergate because we have been operating responsibly in the space for over nine years,” he told analysts.

Meanwhile, Jane Street LLC, the same investment firm that incubated disgraced FTX CEO Sam Bankman-Fried’s crypto ambitions, is buying up stake in the bank., a company that settled with the SEC in 2019 over an initial coin offering, is another buyer of its shares even as insiders conduct a flurry of transactions.

Perhaps, they know something that we don’t.

MakerDAO Treads the Terra Path

MakerDAO founder Rune Christensen unveiled an “Endgame” strategy some months ago to convert its algorithmic stablecoin, currently backed by a mix of worthless tokens and some US dollars into a stablecoin backed completely by fiat currencies. Earlier this week, the protocol unveiled new economics for its tokens. MKR, its governance token, can now be used to borrow DAI, its stablecoin.

The arrangement should provoke déjà vu for those who have been covering cryptocurrencies. Terraform Labs, which was recently charged by the SEC for an unregistered sale of securities, used the same mechanism to prop up the two tokens – stablecoin UST and governance token LUNA – in its network.  

We know how that experiment ended. The chances of a similar occurrence this time around are high because the two tokens in question – MKR and DAI – have an even more convoluted setup than the one that underpinned operations for Terra’s tokens.


DAI has lost its peg many times earlier and, much like most cryptocurrencies, exists in a regulatory vacuum. It is generated in the form of loans only by locking up ether (ETH) in smart contracts. Redemption of DAI is a circuitous affair that involves exchange the tokens for ETH and paying fee. There is also a stability fee that its users pay to borrow the token and it is set by MKR holders.

That complicated mode of operations is why the stablecoin is inherently unstable. According to a recent research paper that compared the stability of four coins – USDC, Tether, BUSD, and DAI, MakerDAO’s stablecoin turned out to be the “least stable” among the four.

MKR, meanwhile, has no real use case except for speculation. Even its utility as a governance as a governance token is doubtful since Christensen calls the shots on important decisions related to the protocol.   The final stage of Christensen’s endgame was a “Phoenix” stance for DAI. The phoenix, as we know, rose from its ashes. This one will not.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.