What the Bank Failures Tell Us: Crypto, FRB, and More.

Silicon Valley Bank, Silvergate, and Signature — these are three banks that crashed one after the other in what has been five full days of uncertainty for the American economy. The financial institutions, in addition to being friendly enough for new and upcoming ventures, had also been receptive to cryptocurrency well before any of its counterparts. Silvergate had close to 90% of its deposits coming from the crypto industry.

While the downward trajectory for SVB and Silvergate was more or less visible before the actual shutdown happened, in the case of Signature, there appeared to be no warnings. This led to speculation that the bank crashes were primarily a regulator-led plot to drive the economy away from crypto. FDIC's limit of insuring only up to $250,000 in bank deposits was a cause of concern for all customers. They started calling up the bank for reassurance; there was also a high-shot of deposit withdrawals that began but which slowed down in three days. Given that the panic was calming down, Signature felt that they could soon settle into their route as before and not suffer through what SVB did. But the regulators decided to seize all branches. This caused many, including Barney Frank, to speculate that perhaps Signature did not have to become the third-largest bank failure. The troubles have also given ground for Republicans to create anti-Democrat campaigns citing mismanagement of the economy.  

Did Crypto Drive this Crash?

The recent bank crises have brought the debate down to two key takes: one, the fractional reserve banking (FRB) system may be flawed, and two, small and medium banks could benefit from taking lesser risks (also read as distancing themselves from exposure to cryptocurrency).

With the FRB, you always have the risk of bank runs and liquidity crises. Often, bank crashes or shutdowns result in chain reactions across all consumers — and this doesn't do well when you have limited liquidity. From this perspective, what happened at SVB or Signature was a traditional case of a bank run powered by the limitations of FRB. The system operates from an assumption that withdrawal demands will not hurt its capacity. Many have started using social media to state why the regulated banks are now no longer credible given this catch in their functioning. So, to have an independent matrix for managing crypto would ideally be the solution.

Crypto and digital asset experts like Perianne Boring say that the American financial system needs to be modernized by relying on the transparency of cryptocurrency. And for those who advocate for this, the 2013 Cyprus crisis is a much-loved example to state. Here, a bailout was offered to Cyprus by Germany, but at the cost of Cyprus giving a one-time tax to raise additional funds — this came from 6-10% taken from the insured and uninsured deposits in its banks. There was, of course, a provision of compensation given to depositors. But, using the Cyprus example to push for trust in crypto makes it a little twisted — primary of all reasons is the fact that the worth of banks in Cyprus was higher than even its GDP. This mismatch made all eyes turn skeptical toward the means: where was this money coming from?

While crypto itself may not have driven the current bank crisis, to use this to assert that only digital monetary assets are credible might be a wrong placement of good intentions.

A noteworthy point to recall would be last year's FTX shutdown. The transparency of cryptocurrency management may not yet be at its pinnacle. There are risk exposures in the form of exchange platforms meddling in client accounts. So, to pitch this as a complete alternative to traditional banking systems would be a shot thrown overboard.

What Happens Now?

Cathie Wood of ARK Invest thinks that American regulators are essentially cutting the country off from an internet revolution. Laying down the failure of traditional banks and pitching crypto as the new alternative, she said, "This debacle would not have been possible in the decentralized, transparent, auditable, and over-collateralized crypto asset ecosystem. Indeed, during the last week, crypt assets behaved like safe havens: along with gold, their prices appreciated."

But, these cannot be seen in blacks and whites alone. America, just as with any other country learning about avenues like digital financial assets, should learn to go hand in hand with the old and the new. Regulation is important to prevent hard landings. And with the cryptocurrency growing further in its expanse, it would need to be assessed and regulated. To let this burgeon out into a parallel financial universe would not exactly be wise.

Equally important is the need to have a clear process for what happens to insured and uninsured deposits when a bank fails. Given that the country is offering compensation (in full amount) to the depositors using the money held in private banks — and not from taxes paid — makes it rather ironical. Because one way or the other, the money is going to come from the public. And how these may go into compensating a section of people who are already rich adds to the moral question of such bailouts. This is an imbalance at its best.

There is a lot to process here. The crisis may not spark a contagion as expected. But a clearer picture can emerge only in a while. When it does, there will be a lot of legislative work to be done.