After the many high-profile crypto collapses we’ve seen the past 12 months, the story that has everyone glued to the screen for once doesn’t involve crypto. To be clear, the crisis of confidence ripping through the US banking system has had its effects on the digital asset industry as USDC, the second largest USD stablecoin, temporarily depegged over the weekend when news broke that some of the reserve assets were caught up in the storm. And as these banks were considered ‘crypto friendly’ – serving tech startups and VC investors – the delayed access to deposits is a concern for many.
But the root cause of the issue has nothing to do with crypto or the tech industry. What we’re dealing with is an old-fashioned asset-liability mismatch. That same story we hear every time we hit the tail-end of a cycle. But this time, it could trigger an irreversible shift as more investors realize there is an alternative.
The chain reaction that exposed fragility in the US banking system was triggered by the liquidation of Silvergate Bank, gained pace with a bank run on Silicon Valley Bank (SVB), and came to a head when regulators took over Signature Bank.
SVB’s troubles stem from parking $91 billion in deposits in long-dated securities such as mortgage bonds and US Treasuries, which were deemed safe but are now worth $15 billion less after the Federal Reserve aggressively raised interest rates. The banks that followed this strategy are also under scrutiny for a potential bailout.
Why did the banks get themselves so upside down? Recall that in 2020, when banks bought these assets, the Fed’s fed fund rate guidance was 0.1% out to 2023. With short duration bonds yielding almost nothing, bank executives bought long duration bonds in a reach for yield. It seemed like a good bet at the time, if one took the Fed at face value. But today, the Fed funds rate is actually 4.75%. The banks’ estimations of interest rate moves were only off by 47 times!
But, we can’t just blame the Fed, bankers need to take responsibility for part of the crisis as they overreacted to Fed messaging. Demand deposits should have been backed by short-term investments, not long-term, to prevent the asset-liability mismatch that precipitated the crisis. In other words, bankers chased profits at the expense of safety. It certainly didn’t help that as soon as news of SVB’s capital raise hit the wires, customers withdrew their deposits at a record clip which started a good old fashioned bank run as SVB could not liquidate its portfolio fast enough to meet withdrawals.
The end result? We’ve just witnessed the 2nd, 3rd and 5th largest bank failures in history, as the Fed engaged in the fastest rate increase in history.
In response to the crisis, the Fed, Treasury and FDIC immediately set up the Bank Term Funding Program (BTFP) to assure banks have the ability to meet the needs of their depositors. In other words, the Fed will buy back the very bonds whose values their policies impacted.
While the contagion has been contained, there will continue to be volatility in capital markets especially in the shares of smaller banks as shareholders sell the stocks of banks where they see potential risk, from deposit mix, funding sources and, even, industry concentration. So, as a bank depositor you are safe but as a bank investor, not so much.
Was there any good news? Yes. Bitcoin and other digital assets held up well during this period and behaved exactly as they were meant to in periods of fiat crises. In fact, Bitcoin was created during a time like this. For immutable evidence, see the message Satoshi Nakamoto left within bitcoin’s first block: ”The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
More people are finally understanding what the promise of blockchain-based finance truly means at this very moment. This banking crisis may prove to be a watershed event in the adoption of digital assets by institutional investors and major corporations.
Compared to traditional finance, counterparty risk is far more transparent with decentralized finance, and it’s events like these that make investors realize there is an alternative where owners of digital assets are indeed the only ones in control of those assets. No intermediary gets to gamble with your assets, and nobody can bank run the Bitcoin blockchain. Greater appreciation of these fundamental concepts is propelling the next generation of finance. Built on uncompromised transparency and immutable verifiable financial information. Built on blockchains.
This isn’t to say that crypto and the broader tech industry won’t be affected. In fact, the typical evolution of a tech boom and bust cycle (boom, dislocation, consolidation, and rebirth) is already underway. We are now in the consolidation phase where the stronger players still in the game are moving to the top of the industry. Companies in a leading position like Hex Trust now have the task of reshaping the industry as the market evolves, making the right choices that enable sustainable growth.
Now more than ever, investors of all stripes must have a careful vetting process to assess potential counterparty risks. And, don’t just manage perceived risk. Actually segregate and protect your digital assets using high-grade security frameworks designed for enterprises. Choose reliable and trustworthy partners like custodians that operate using transparent security protocols, where you as the customer are always in full control of your own assets. Only work with companies that provide real, on-chain connectivity to decentralized markets. Never chase profits at the expense of safety.
Across tech, crypto, and finance, many of the companies that failed the past year went under because they failed to manage risk. So the crisis this week serves as a timely reminder that investors should always ask the same pressing question: who do you trust?