Why Financial Analysts Missed SVB's Red Flags
Original title: "Why Financial Analysts Missed Silvergate’s Red Flags》
Original title: "
Author: Brett Harrison
Compilation of the original text: Colin, SevenUpDAO
Silvergate Corp. (SI) is a public company with at least 10 sell-side research and financial analysts. These analysts evaluate Silvergate (and other regional banks) and make recommendations (eg, buy, sell, hold) on the company's stock or debt.
Personally, these analysts continued to recommend SI even after the news of the collapse of the FTX cryptocurrency exchange broke. For example, on Nov. 9, Canaccord analyst Joe Vafi wrote: "If FTX ceased operations or some customers migrated to other exchanges, Silvergate would likely still get that volume within its operations." Vafi gave Silvergate a buy Enter rating and target price of US$150. Silvergate closed at $34.69 on Nov. 9 and hasn't traded that high since.
Only after a lot of damn things ensued — a letter from a member of Congress to Silvergate Bank, its $4.3 billion loan from the Federal Home Loan Bank, news of the Justice Department investigation, a joint meeting of banking regulators on the risks of crypto assets. Statements like "Banking Organizations", a notice that Silvergate would delay the submission of its annual report, which questioned its own ability to "go as a going concern", and the exodus of many of the bank's key partners - the analysts ultimately caved in. But even that isn't quite the case, with some downgrading Silvergate to hold from buy.
This change of heart is too little, too late. The damage has been done. On March 8, Silvergate announced that its bank would cease operations and go into voluntary liquidation.
I think there was a fundamental problem with Silvergate long before November that traditional analysts missed or were at least grossly underappreciated. Why?
Sell-side financial analysts follow a well-worn path. They earned undergraduate degrees in finance, economics, mathematics, and more. They hold entry-level positions as senior analysts. Maybe earn a CFA, Series 7 or MBA and become a specialist in a specific sector or subsector (eg, regional banking).
This path gave them the lens of traditional finance (TradFi), leaving them with a blind spot in decentralized finance (DeFi), causing them to miss out on the hassles of banking associated with cryptocurrencies.
(The same goes for analysts at traditional rating agencies, who were slow to downgrade Silvergate.)
In Silvergate's case, they missed several red lights.
Are there professionals?
For most of its life, Silvergate was a sleepy Southern California regional bank offering a traditional suite of personal and business banking services. In 2016, it pivoted and went all-in on cryptocurrencies, transforming itself into a bank that calls itself an "unconventional bank."
In its 2019 regulatory filing, Silvergate expanded on this, saying that its "business model and vision are different from traditional banks." In addition to traditional banking services, it is also "serving for emerging financial technology ('financial technology') in the US and beyond." fintech') companies providing specialist commercial banking products and services."
Analysts' bullish recommendations lend Silvergate a cloak of institutional legitimacy.
However, this tectonic shift in business model has not been supported by crypto-related acquisitions or meaningful capital investments, casting doubt on whether Silvergate has the staff and business to run a crypto bank.
trading network
Silvergate's flagship "specialty business banking product" is the Silvergate Exchange Network (SEN), which CoinDesk describes as "a 24/7 instant settlement network used by some of the largest trading entities in the space." replacing cumbersome wire transfer transactions…” The company shut down SEN on March 3 and removed a page describing the service from its website.
Building on the success of SEN, Silvergate then offered SEN Leverage, a bespoke loan that “allows institutional clients to trade any asset on the platform using leverage collateralized in Bitcoin or U.S. Real-time loan disbursement and repayment network (SEN).” The service also shut down on March 3.
While these services may represent a paradigm shift, they are also services that other federally insured banks cannot offer. Furthermore, Silvergate CEO Alan Lane admitted in a 2021 interview that SEN Leverage had not been approved by the banking regulator: “It’s not like an approved product, it’s an unapproved product, and that’s what we talk about in the banking world. One of the ways of it."
Additionally, these services directly tie Silvergate's growth to the volatility and vagaries of the crypto market. Any projection of Silvergate's future value requires a deep understanding of these markets and use cases that are still unfolding.
money laundering control
The SEN is key to Silvergate's customer acquisition strategy. The strategy worked. Silvergate's client base has grown from 20 cryptocurrency clients in 2016 to more than 1,600 by 2022. These clients include hedge funds, more than 100 domestic and foreign cryptocurrency exchanges, and companies working on token projects.
Importantly, customer deposits are primarily digital assets, which are not a particularly safe or stable source of funding, as they directly expose Silvergate to non-traditional risks, particularly volatility in the crypto market. These risks were exacerbated by Silvergate’s lending to clients facing the same crypto-related issues. As one investor told me, “It all seems like a disaster if crypto prices fall.” And they do fall.
Also, consider that these clients use SEN to facilitate "more than $1 trillion in payments since its inception in 2017" (highlighted in the original 2022 Silvergate investor presentation).
Incredibly, a mid-sized bank, even one with "twice as many compliance staff as a bank of its size," would be able to perform the necessary AML checks to spot and stop suspicious activity. Many clients and so many currency transactions in real time. The volume and speed of those deals - the source of many analysts' reassuring forecasts - overwhelmed Silvergate's compliance agency.
Some customers realize this weakness and use SEN for illegal purposes. According to court documents, FTX and sister company Alameda Research took advantage of the loose nature of Silvergate's compliance program to create accounts for a seemingly fictitious subsidiary (Northern Electronics) to hide funds used for Alameda's trading activities.
However, even before the FTX debacle, there was evidence that customers were using SEN for illicit purposes as early as July 2021, and specifically for money laundering in August 2022.
A Jan. 24 report in New York magazine Intelligencer laid out a sweeping indictment of this nefarious activity, describing Silvergate as "the bank of choice for more than a dozen cryptocurrency companies that ended up being investigated, shut down, fined, or bankrupted." The story pointed to a number of clients who broke the law (for example, convicted Australian cryptocurrency Ponzi scheme artist Stefan He Qin and Bittrex, a cryptocurrency exchange and one-time Silvergate shareholder and customer, who were hit by U.S. authorities for moving funds on behalf of Iran. sanctions and Syria).
Other investors and researchers are acutely aware of Silvergate's problems and share their views openly (for example, veteran short seller Marc Cohodes told The Block, "Silvergate is a publicly traded crime scene and Alan Lane is a prison"), So even wrote to Silvergate's auditors and regulators, describing the problem and urging them to take action.
Some were quick to point out that Silvergate was a failure of banking, not cryptocurrency. But I think this is yet another TradFi failure: Like institutional investors who invested in failed lenders Celsius Network and FTX, Silvergate analysts use traditional investment techniques and metrics to value non-traditional companies, causing them to miss the embedded Formal encryption risk ultimately led to the failure of the company. We need TradFi to put on a DeFi lens if we are going to stop the crypto bloodbath.
