Bitcoin’s blessing: How crypto became a haven in the bank chaos

This month’s failure of three regional US banks has turned into both a curse and a blessing for crypto firms.

Silvergate Bank, Silicon Valley Bank and Signature Bank all had links to the digital assets sector and their collapse creates a challenge for crypto companies that need pipelines into the traditional banking sector to convert fiat currencies into crypto assets and vice versa.

In the immediate aftermath of the failures and the tremors that have reverberated throughout the global finance system, however, crypto assets have benefited from the fear that has coursed through the banking sector and the demonstration the lenders’ failures have provided of its fragility.

Cryptocurrencies have staged a comeback as the global banking system is rattled by crisis.Credit:Getty Images

The crypto market has been wallowing since it cracked almost 18 months ago, with its market capitalisation crashing from $US2.8 trillion then to about $US912 billion just ahead of the runs on the three banks that forced their seizure by the regulators.

This week, however, the market has been valued at about $US1.17 trillion ($1.75 trillion) – 22 per cent more than it was worth immediately ahead of the bank collapses.

Bitcoin’s price has followed a similar but exaggerated trajectory. From its high of almost $US70,000 in October 2021 the dominant crypto asset had fallen to $US19,933 on the weekend that Silicon Valley, the largest of the three banks, closed its doors.

Despite sliding 3 per cent on Monday on the news that the largest of the crypto exchanges, Binance, is being sued for allegedly operating an illegal exchange, it is still trading above $US27,000, or about 36 per cent higher than its price before the bank failures.

All three of the banks had crypto links, although Silicon Valley’s were more limited as it held $US3.3 billion of the $US40 billion of deposits that help back cryptocurrency firm Circle’s USDC stablecoin.

Silvergate’s collapse is probably the most disruptive for the crypto sector. It was a pioneer of banking for cryptos, establishing a platform in 2017 that enabled seamless transfers, in real time, between crypto assets and cash. The bank didn’t charge fees for transactions on its platform.

That helped investors, particularly hedge funds and other institutional traders wanting to transact instantly in what is a volatile market, become far bigger players in the crypto space.

When it failed, about $US16.5 billion of Silvergate’s $US88.6 billion of deposits were owed to crypto customers.

One of its directors, Barney Frank (of the Dodd Frank legislative response to the 2008 financial crisis fame) has alleged that the New York Department of Financial Services, which took possession of the bank earlier this month, wanted to send a message to other banks not to provide services to the crypto sector and that a condition of any sale would be to cut all links with the sector. (It should be noted that the bank had been experiencing a major run on its deposits before the regulators seized control).

The alacrity with which Signature was closed down has fuelled suspicion about the authorities’ motives because bank regulators have made it clear that they have been increasingly concerned about links between the crypto world and conventional banks.

Earlier this year, the Federal Reserve, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency issued a joint statement in which they said they had significant safety and soundness concerns about banks’ exposures to crypto assets, and pledged to monitor those exposures closely.

In a sense, the regulators were right.

Bitcoin has, perversely, been acting as a safe haven from the turmoil in the banking sector precisely because it isn’t part of that sector.

Signature and the other two failed banks all held deposits that backed stable coins. The regulators were worried that, given the volatility of the crypto sector amid constant scandals and collapses of major firms like FTX, a panicky rush to redeem those coins could effectively ignite a run on the banks with large exposures to crypto firms, spreading contagion from the crypto world into the mainstream banking world.

In the weeks leading up to the runs on the banks, the value of all crypto assets had fallen more than 15 per cent in a continuation of the fallout from FTX’s implosion late last year.

The bank failures mean that the crypto sector has essentially been de-banked, at least in the US.

Investors may again have to resort to cumbersome, costly and time-consuming measures to move funds in and out of the sector, or turn to non-banks or banks in less tightly regulated jurisdictions, adding more dimensions of risk and costs for investors in an already-risky sector.

That doesn’t appear to have impacted sentiment yet, although it may be impacting liquidity and volatility. Trading volumes in Bitcoin have, for instance, been thin despite the surge in its price. Illiquid markets tend to be volatile.

The true believers in crypto assets are claiming that the collapses and frissons of fear running through the conventional banking system after the bank failures and the near-failure and forced takeover of global giant Credit Suisse actually help promote cryptocurrencies and Bitcoin in particular.

Stablecoins might need access to banks and US dollar cash to make good on their promise that their coins are backed by, and pegged to the value of, real assets, but the appeal of a pure cryptocurrency is that it isn’t part of the mainstream banking system.

Bitcoin has, perversely, been acting as a safe haven from the turmoil in the banking sector precisely because it isn’t part of that sector.

The bank failures have significantly raised expectations that US interest rates, if they haven’t peaked, are very close to that peak, with financial markets now again flagging a cut in rates later this year despite Fed chair Jerome Powell’s recent comments indicating that a rate cut this year hasn’t been contemplated.

More than most risk assets, cryptos and Bitcoin especially are leveraged to interest rate settings. Like other rate-sensitive assets classes such as technology stocks, they plunged as rates rose rapidly last year, but have bounced as markets have become convinced that the stress in the banking system will cause the rate cycle to turn earlier than the Fed has been signalling.

The effect of the banking crisis is equivalent to at least one and perhaps several of the Fed’s 25 basis point increases. It will increase bank funding costs, which will be passed on to borrowers, and makes banks more wary of lending.

The banking system and the real economy it serves will become more risk-averse and tighten financial conditions, forcing the Fed to respond.

That’s the theory, at least, which has taken hold in financial markets, including the crypto market, and which provides the blessing that has driven crypto prices higher, particularly Bitcoin’s, despite the curse of the lost access to the most crypto-friendly banks.

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