Digital Currency Bank Silvergate Capital conducted an IPO and listing on the NYSE this week on November 11, 2019. The commercial bank is at the forefront of providing badly needed banking services to the crypto industry as it faces regulatory uncertainty. Without any competition, the bank is uniquely positioned to dominate market share in this rapidly growing industry.
In its 6 years of operation, Silvergate has grown to be the major digital currency bank for exchanges, funds and other institutional clients in the United States. Based in La Jolla, California, Silvergate shifted its focus to digital asset companies in 2013. Since then, the companies deposits have grown to 1.6 billion and boasts 483 customers in the digital currency industry.
The California-based commercial bank raised $40 million through offering 3.3 million shares at $12, with 25% primary shares priced at $10. At the last daily closing price of 13.55, the bank commands a market cap of $252.86 mm. The company had originally planned to raise $52 mm, but decided to sell 500k less secondary shares while offering an additional 54,605 primary shares.
Major institutional investors owning more than 5% of the company are BankCap Partners Opportunity Fund, Partner Reinsurance Company, FJ Capital Management, Park West Asset Management, Senvest Master Fund, Fintech Investment, EJF Sidecar Fund. This group of investors control 40.5%. Barclays, Keefe Bruyette Woods, Sandler O'Neill and Compass Point acted as underwriters for the IPO. Other notable investors are Barry Silver and his Digital Currency Group.
Silvergate is led by 56-year-old Director and Chief Executive Officer of the Bank, Alan Lane, grandfather of 21 and devout Catholic, who has been with the company since 2008 and has over 35 years of corporate and financial institution leadership experience. Mr. Lane started his banking career as a teller at a local California bank and slowly worked his way up to holding positions of Director, President and Chief Operating Officer of Southwest Community Bancorp; Vice-Chairman and Chief Executive Officer of Financial Data Solutions, Inc.; and Director and Chief Executive Officer of Business Bancorp.
Alan was instrumental in educating state regulators about Bitcoin. He invited the California State Banking Department and Federal Reserve Bank of San Francisco in the Summer of 2014 to a presentation on Bitcoin and how he believed the industry badly needed banking services. The meetings proved to be “really fruitful and established a close relationship with the regulators.
“I put two and two together and I thought, well it might disrupt banking long-term but in the short-term these companies need banks,” Alan said. “They’re not doing anything wrong. They’re not doing anything illegal or immoral. If they were we wouldn’t be banking them.” - Alan Lane for CNBC
Silvergate was originally founded as a thrift in 1988, only to be restructured into a commercial bank 10 years later by Chairman Dennis Frank, an ex-Goldman Sachs banker. Under his leadership, the bank stopped its mortgage operations in 2005, three years before the Great Financial Crisis. Frank hired Lane as CEO in 2008 just as the crisis was affecting banks worldwide. Silvergate was able to stay profitable even during the GFC and grew its operations.
“For the most part, the larger banks in the U.S. have stayed away from banking cryptocurrency businesses. In the U.S. and particularly Europe, we see smaller, more technologically advanced banks partnering with cryptocurrency businesses.” -David Ripley, COO of Kraken, for CNBC.
The bank’s primary function is the development and operation of the Silvergate Exchange Network (SEN), a network of digital currency exchanges and institutional investors set up for 24/7 U.S. dollar transfers between accounts facilitated by the company’s business online banking data processing system. All transactions are processed through Silvergate’s API and back end. The transfers occur instantly, unlike ACH or electronic funds transfers, which can take a few hours or days to complete. Clients use their system to quickly shift U.S. dollars from one exchange or account to another. Silvergate is the only US back to provide this type of service and willingness to work with digital currency companies and has seen significant growth to date. Since launching SEN, the bank claims to have onboarded more than 60% of all eligible clients to the program.
Most if not all digital asset exchanges operating in the United States are thought to be clients of Silvergate Bank. Kraken openly talks about its relationship, but others like Coinbase have yet to refute their dealings.
Silvergate faces little to no competition from other banks currently for even basic services such as opening deposit accounts and providing banking services. The regulatory environment for digital currencies is vaguely defined and yet to be a politically protected position. Any bank working with the digital currency industry exposes itself to greater regulatory oversight. It’s actually an understated risk on the bank’s part. Clear crypto legislation is nebulous and unoptimized, and the bank knows this. With time though, clear rules should be set by the US Congress, until then, the bank is right to worry about its position.
Other services offered by Silvergate are “a full suite of corporate cash management solutions from deposit, reporting and reconciliation (remote deposit capture, online banking, mobile banking, file / reporting automation, API, check reconciliation), liquidity management (positive pay, ACH positive pay, off balance sheet deposit sweeps), and payment solutions (domestic and foreign wire transfers and ACH origination and receipt transactions).”
Since opening its doors to crypto companies, deposits at the bank have rapidly grown. As per the S-1, cryptocurrencies, labeled as non-interest bearing deposits, constituted 88.2% of the banks deposit base at the end of 2018. YoY growth in crypto deposits was 16.6% for 2018. Post-IPO I would expect the press coverage to bring them a greater number of clients.
Silvergate's reported financials improved YoY. For the 9 months ending in 2018
- Cost of Deposits down 80.7%
- Cost of Funds down 75.3%
- Net Interest Income up 67% to 48.7 mln.
- Noninterest income up 185% to 5.5 mln
- Net Income rose 150.9% to 14.3 mln
The bet Silvergate is making is that institutional demand and usage of digital currencies will continue to grow in the future. Silvergate currently services 300 institutional investment funds with 7.5-10 billion assets under management. Most all of these assets (8.5bln) were invested after 2014. SEN will be the bank’s flagship product for the near future as greater amounts of institutional capital needs a transparent, secure, and regulated payment system.
Clients typically hold either investment or operating funds in the bank. Exchanges probably hold the vast majority of their funds in operating accounts ready to be deployed. Institutional funds are kept ready for use, but are not marked for company operations. Clients are hand selected and chosen for their long term commitment to the crypto industry.
Investing into Silvergate should not be considered a proxy for purchasing crypto. Price changes will have little effect on share prices. Instead, owning Silvergate stock is a way to capitalize on growing institutional adoption of cryptocurrencies. Silvergate is agnostic to the kinds of digital assets it holds for clients. Bitcoin could collapse and the bank probably would still profit from its institutional clients. No one knows which digital assets will be most used in a decade, with Libra, Filecoin and others on the horizon. Instead, Silvergate will continue to be at the forefront of small agile banks ready to serve industry needs.
Silvergate Capital Corp stock currently trades at $15.10, up 20% from the time it was listed on the NYSE. I purchased a small position on opening day and I plan to continue to add more once the company releases their first 10-k later this quarter. My belief is that Silvergate will continue to dominate this niche need for crypto companies. Deposits will increase 20-30% YoY, driving net income/interest.
Disclaimer: I have a long position in SI which I opened on November 12. I do not plan to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with Silvergate, nor any of the companies I work with.