Crypto’s Banking Problem Is Not Ironic

The institution of personal banking is incredibly powerful.

You don’t even need to read a research report or some harrowing personal account to prove it. Instead, just pretend for a moment that all your bank accounts are frozen. Your credit cards don’t work either.

How will you get on?

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Well, hopefully you have a stash of cash under your mattress. Or you have bitcoin and you live near enough places that genuinely participate in the Bitcoin circular economy. Maybe you live in Argentina and you can use a crypto dollar stablecoin like tether because your sovereign currency has let you down since the 1980s.

Otherwise, you’re in a tough place.

The low-hanging fruit here is a clear call to action: We need more of these circular crypto economies. Communities, counties, states, entire countries – an example being El Salvador’s Bitcoin Beach – that operate completely separate from the legacy banking system.

But while these circular economies continue to build out, banking and crypto are still intimately tied. Just look at last week’s news dominated by Silvergate Bank running into a brick wall of trouble that was punctuated by its stock (SI) losing over 50% of its value on Thursday.

Before Silvergate and after Silvergate

Silvergate is the bank for a lot of crypto businesses that tend to have problems maintaining banking relationships.

Silvergate opening up its doors to crypto is viewed as a critical juncture for crypto businesses, especially crypto exchanges. My colleague Daniel Kuhn highlighted as much in a piece published last week titled “Before Silvergate and After Silvergate” borrowing from a quote by now-disgraced FTX founder Sam Bankman-Fried about how life was better for crypto companies with Silvergate in the fold.

If we look at crypto exchanges, Silvergate is so well-liked because a) it gives access to banking in the first place and b) Silvergate ran the Silvergate Exchange Network (SEN). SEN, which was recently disabled, allowed 24/7 instant settlement between Silvergate bank clients at any time, including nights and weekends. It functioned sort of like how Venmo or CashApp settles debts between friends for late-night ramen or pizza or whatever. Access to SEN attracted a lot of crypto exchange clients including Binance.US, Kraken and Gemini.

And then the FTX collapse happened, which had Silvergate customers antsy and led to billions of dollars in deposit withdrawals. Silvergate subsequently dipped into the Federal Home Loan Bank system to prop up operations.

Things were obviously tough for Silvergate (and other crypto banks, surely), and it got even tougher when U.S. Senator Elizabeth Warren (D-Mass.) sent Silvergate a scathing letter while the White House was publishing blog posts about its crypto concerns. Cue even more withdrawals from Silvergate and the shutdown of the lauded SEN last week.

To be clear, the regulators and politicians didn't actually say crypto exchanges and companies shouldn’t be banked, but they injected uncertainty into the industry. And the funny thing about Silvergate is that it didn’t run into issues because it was making loans using bitcoin and crypto as collateral. It ran into issues because of a bank run. A bank run encouraged by the U.S. government.

This is where a good argument about the potential ill effects of Choke Point 2.0 comes into play, to use CoinDesk columnist and venture capitalist Nic Carter’s phrase. I’m not going to dive into the intimate details of Choke Point 2.0 (basically the idea that the government can threaten regulation against banks if they service certain companies or certain industries), but I want to tackle the banking problem in engenders.

Crypto’s banking problem is not ironic

Silvergate’s issues have made it somewhat obvious now that crypto does in fact have a banking problem. And most crypto critics see this and say: Crypto was made to skirt the banking system, it’s really funny that crypto needs banks to skirt the banking system.

Funny? Well, maybe. But I’m not laughing.

First off, banks and crypto can coexist (yes, even in a hyperbitcoinized world) and in my view they will and should. Just because the option to opt out of using a bank exists with bitcoin or some other crypto doesn’t mean that everyone will shun banks entirely. In fact, honest banking can be a net positive.

There will, of course, be (and are) a hardcore subset of self-sovereign individuals who buck third parties entirely, but there are billions of people in this world. Organization of those people is far easier with some reliance on third parties. The world that bitcoin and crypto can encourage is a world where those third parties are more honest. More honest banks in the business of keeping your money safe and providing responsible lenders access to future capital (i.e., credit) is better than fewer honest banks.

Hand-wavy, I know. But potentially true.

Lastly, crypto companies needing banks to “skirt the banking system” highlights exactly why the banking system needs to be skirted (or at least somehow broken up). Imagine for a moment there is an institution in a country that is so critically important that the simple threat of regulation against that institution for servicing a client in an undesirable industry brings that undesirable industry to its knees. But no need for imagination: This is exactly what is happening in the United States. We now see an implicit promise of future regulation from the executive and legislative branch of the U.S. government if the banks that service crypto companies don’t shape up. Whatever that means.

While I don’t think this is a good thing, it can be if not overdone. If there is a higher bar for banking access for crypto companies that leads to more thorough diligence that somehow results in fewer bad companies in the ecosystem, ultimately retail will be safer and the system less sensitive to future crypto shocks.

Maybe that is what happens. For now, I choose cautious optimism.