Crypto regulation: A postmortem after Silvergate, Signature, and Silicon Valley Bank

During the past few weeks, the fintech and crypto industries and the broader finance sector have been experiencing extremely challenging times. 

The longer-term implications of crypto regulation are likely to be complex and far-ranging. How firms respond could change the crypto landscape permanently. 

It will take months for these banks to wind down their operations, but their effects on the market are already profound. 

The collapse of Silvergate, Signature, and Silicon Valley Bank came almost simultaneously. Many businesses and customers have been left uncertain, and it remains to be seen what the ultimate impact will be for all areas of financial services from incumbents to fintech and crypto start-ups.

Additionally, after the FTX fallout, regulators have been closely monitoring the crypto industry. The collapse of these banks has exacerbated the sentiment, particularly in the US. 

The latest event certainly harkens back to the global financial crisis, with concerns that the problem could spread to other banks without strong capital and robust risk management plans.

As a result, lawmakers have been pushing for stricter oversight of the crypto industry, seeking to protect investors from similar events in the future.

A postmortem on the regulatory landscape is presented in this article.

A renewed focus on US Government

It is now considered more likely that Congress will pass stricter banking legislation. The House Financial Services Committee will review any new regulations concerning banking, including deposit insurance and federal monetary policy.

The Federal Reserve Board outlined on 13 March its plans to review how well Silicon Valley Bank (SVB) was supervised.

The US Securities and Exchange Commission Chairperson Gary Gensler spoke strongly about this issue. He observed SVB's collapse and emphasised the need for financial safeguards in a statement two days later.

 "Lest we forget, 8 million Americans lost their jobs, millions of families lost their homes, and small businesses across the country folded as a result of the financial crisis of 2008. To that end, I think the SEC has a responsibility to help protect financial stability," he said. 

Additionally, US Senator Elizabeth Warren who has previously advocated a more conservative approach to crypto regulation

Concentration risks

Silicon Valley's deposit base consisted primarily of uninsured venture capital, while Silvergate's was dominated by crypto deposits. While Signature Bank was more diversified, it also had crypto exposure, according to S&P. 

"Silvergate demonstrates what can happen when a bank is overly exposed to one sector. Discouraging banks from providing deposit accounts only exacerbates this problem by creating fewer options for any one sector to obtain banking services. The problem is not about crypto, but concentration risks," said Sheila Warren, CEO of the Crypto Council for Innovation.

The issue is not solely about crypto, but rather the risks associated with a bank having too much exposure to a single sector. If banks are not allowed to provide deposit accounts, this reduces the options for industries to obtain banking services, which could lead to even more concentration risks.

Inconsistency in regulation 

David Sutter, CEO of Opentrade, a Web3 treasurer and institutional investment platform, says the collapse has been driven by unstable and tightening economic conditions.

"The events we've seen over the past few days have been caused by problems in the US financial system related to historic monetary tightening by the Fed and the inherent instability of fractional reserve banking. Painting crypto as the cause of these events is just not factually accurate,” he said. 

Ilya Volkov, CEO of YouHodler, meanwhile says regulatory inconsistency is another factor. 

The Federal Reserve, he says, is effectively telling anyone not using the four largest banks that they have limited protection as SVB was not subject to the Liquidity Coverage Ratio despite being the 16th largest bank in the country. 

This inconsistency has made midsize banks more vulnerable to liquidity risk and has raised concerns about their ability to meet unexpected cash needs. 

Overregulation 

While inconsistency and concentration may not be the only issues with existing regulations, the impact following these collapses may, according to some, lead to overregulation, particularly for parts of finance seen as riskier such as crypto.

Vlad Totia, research manager at Zilliqa, an enterprise blockchain platform, thinks we may be approaching an overregulated environment in the US. 

"The US moves into an area where it's putting almost draconic regulations disproportionately on crypto entities. An excellent example is the sudden and strict staking ban that hit Coinbase and Kraken, among others,” he said. 

The SEC issued a Wells notice on March 22, targeting some aspects of Coinbase's business, including the assets listed on its crypto exchange and its staking service Coinbase Earn.

Kraken settled with the SEC last month, ending staking services for US customers and paying $30m in penalties.

“This only solidifies the competition, which at this point is mostly Binance. At this rate of regulating crypto markets, I believe we will soon reach a mass migration of crypto entities from the US to offshore jurisdictions, where the rules are laxer," Totia said. 

What's Next? 

In his analysis of US regulation, Sutter says there needs to be security and transparency.

“I ask US regulators to focus more on the safety and soundness of the broader financial system and economy and less on whether or not a basketball card NFT is a security. I also call on regulators to pass bipartisan legislation that provides clear rules of the road for crypto and payment stablecoins, bringing stability, safety, and clarity to all involved," he said.  

In the US, a more conservative approach to cryptocurrency regulation appears likely following Silvergate, Signature, and Silicon Valley Bank, as regulators seek to avoid a repeat of the 2008 banking crisis.

It remains to be seen whether the US policies will strike the right balance between effective, impactful regulation, staying consistent, and not deterring investment.