On Nov. 11, the cryptocurrency exchange FTX declared bankruptcy. It’s a saga that’s played out through November, but here’s the bare bones of it: After a Nov. 2 CoinDesk article raised questions about FTX and a sister research firm, a rival exchange, Binance, announced on Nov. 6 its sale of $529 million of FTX’s cryptocurrency. In a panic, customers then sought to withdraw $6 billion and by Nov. 10, FTX CEO Sam Bankman-Fried was trying to raise $8 billion to keep the exchange alive.
This isn’t just a modern version of the old-fashioned bank run. FTX’s new CEO, John J. Ray III — who led the restructuring of Enron Corp. in 2001 — stated in a filing that he’s never seen such a “complete failure of corporate controls” in his 40 years of experience. “From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented,” he said.
The fallout promises serious ramifications for the digital assets space — and may impact some banks. BlockFi, another cryptocurrency exchange that was bailed out by FTX last summer, filed for bankruptcy protection on Nov. 28. Those two bankruptcies have impacted Memphis, Tennessee-based, $1.3 billion Evolve Bank & Trust, which operates a banking as a service platform for fintechs including FTX.
The bank stated its exposure to FTX was in deposit accounts for a limited number of FTX customers, whose funds would be released once Evolve gets approval from the bankruptcy court handling the FTX case. Evolve also issued credit cards for BlockFi customers through a relationship with Deserve; those accounts were suspended. “Evolve has no financial exposure to BlockFi or to the credit card program they marketed,’’ Evolve said in a statement Thursday.
“To be clear, Evolve did not lend to FTX or their affiliates; we do not have corporate or deposit accounts with FTX or their affiliates; we do not lend against crypto; we do not offer crypto custodial services; and, we do not trade crypto,” Evolve said in an earlier statement to customers. Evolve also said the bank has never invested or transacted in crypto.
A larger bank also appears to be impacted. La Jolla, California-based Silvergate Capital Corp., with $15.5 billion in assets, said in a statement that its FTX exposure was less than 10% of its $11.9 billion in digital assets deposits; it later said that BlockFi deposits comprised less than $20 million. However, funds from digital assets clients make up 86% of Silvergate’s deposit base, according to its most recent earnings presentation. The rest are brokered, explains Michael Perito, a managing director at Keefe, Bruyette & Woods. And now, he says, “their targeted core customer base is under a lot of stress.” As a result, Kroll Bond Ratings Agency placed Silvergate’s ratings on watch downgrade on Nov. 21.
“As the digital asset industry continues to transform, I want to reiterate that Silvergate’s platform was purpose-built to manage stress and volatility,” said Alan Lane, CEO of Silvergate, in a press release. The bank declined comment for this article.
FTX may be the worst but it’s not the only crypto-related incident this year; it’s not even the first bankruptcy. The volatility has resulted in what has been dubbed a crypto winter, marked by a steep decline in prices for digital assets. The price for bitcoin peaked on Nov. 8, 2021, at $67,567. As of Nov. 29, 2022, that value hovered just above $16,000, with a market cap of $316 billion.
Even if banks don’t hold cryptocurrency on their balance sheets, there are many ways that a chartered institution could be directly or indirectly connected. Erin Fonté, who co-chairs the financial institutions corporate and regulatory practice at Hunton Andrews Kurth, advises all banks to understand their potential exposure.
She also believes that crypto could be at an inflection point. “Some of the non-sexy elements of financial services are the ones that keep you safe and stable and able to operate,” says Fonté. “It’s the compliance function, it’s the legal function, it’s proper accounting and auditing, internal and external. It’s all those things that banks do day in and day out.”
That could result in more regulation around crypto, and more opportunities for banks. “A lot of people are getting hurt, and have gotten hurt this year,” says Lee Wetherington, senior director of corporate strategy at Jack Henry & Associates. “That gets legislative attention and that certainly gets regulatory attention.”
What Could Change
Legislation could target crypto exchanges directly, but legislators are also looking at the banking sector. In a Nov. 21 letter, the Senate Banking Committee urged bank regulators to continue monitoring banks engaged in digital assets. They specifically called out SoFi Technologies, which acquired a chartered bank in February 2022 and subsequently launched a no-fee cryptocurrency purchase option tied to direct deposits. “SoFi’s digital asset activities pose significant risks to both individual investors and safety and soundness,” wrote the legislators. “As we saw with the crypto meltdown this summer … contagion in the banking system was limited because of regulatory guardrails.”
In a statement on SoFi’s Twitter account, the company maintained that it has been “fully compliant” with banking laws. “Cryptocurrency remains a non-material component of our business,” SoFi continued. “We have no direct exposure to FTX, FTT token, Alameda Research, or [the digital asset brokerage] Genesis.”
Currently, the Federal Reserve and Federal Deposit Insurance Corp. require notification from banks engaged in crypto-related activities; the Office of the Comptroller of the Currency takes that a step further, requiring banks to receive a notice of non-objection from the agency. More regulation is likely, says Fonté, and could include investor and consumer protections along with clarity from the Securities and Exchange Commission and Commodity Futures Trading Commission. “There’s a lot that’s going to come out there that is going to reshape the market in general, and that may further define or even open up additional avenues for banks to be involved if they want to be,” she adds.
Opportunities in crypto and a related technology called blockchain could include retail investment products, international payments capabilities or trade settlement, or payments solutions for corporate clients that leverage blockchain technology — such as those offered by Signature Bank, Customers Bancorp and Silvergate.
The risks — and opportunities — will vary by use case. “We’re being presented with entirely new risks that haven’t existed in the past,” says John Epperson, a principal at Crowe LLP.
Banks could be seen as a source of safety and trust for investors who remain interested in cryptocurrency. Larry Pruss, managing director of digital assets advisory services at Strategic Resource Management, believes banks could win back business from the crypto exchanges. “You don’t have to compete on functionality. You don’t have to compete on bells and whistles. [You] can compete on trust.”
James Wester, director, cryptocurrency at Javelin Strategy & Research, believes that with the right technology partners, banks can approach cryptocurrency from a position of strength. “We understand this stuff better,” he explains. “We understand how to present a financial product to our consumers in a safer, better, more transparent way.”
Wetherington recommends that banks consider cryptocurrency as part of a broader wealth offering. He’s visited bank boardrooms that have looked at how PayPal Holdings and other payments providers offer users a way to buy, sell or hold digital assets, and whether they should mimic that. And they’ve ultimately chosen not to mirror these services due to the reputational risk. “You can’t offer buy, hold and sell of a single asset class that is materially riskier than any number of more traditional asset classes,” he says. “If you’re going to offer the ability to buy, hold and sell a cryptographic monetary asset, you should also be making available the opportunity to buy, hold and sell any other type of asset.”
But all banks could consider how to educate their customers, many of whom are likely trading cryptocurrencies even if it’s not happening in the bank. “Help those customers with things like tax implications … or understanding how crypto may or may not fit into things that their retail customers are interested in. That’s one of the things that financial institutions could do right now that would be good for their customers,” says Wester. “There’s a real need for education on the part of consumers about [this] financial services product.”