The unsettling outflows from hundreds of regional banks were triggered by the recent downfall of three prominent banks, namely Silicon Valley Bank, Silvergate Bank, and Signature Bank. The reverberations of these crises, reminiscent of the ones in 2008 and 2013, have prompted the US Federal Reserve to establish a new backstop facility reportedly valued at $2 trillion.
My first encounter with bitcoin (BTC) happened a decade ago when its value skyrocketed amidst the Cyprus banking crisis, piquing my interest in this novel form of digital currency. The imposition of a 10% withdrawal tax by local authorities had left many Cypriots discontented, inadvertently driving some towards the concept of decentralized digital currency.
According to Omkar Godbole's analysis, many others, like me, have also noticed some similarities between the current week's happenings and past events. Once again, bitcoin's value has surged on conjecture that the financial turmoil within U.S. and European banks will highlight the cryptocurrency's unique features of being free from intermediaries and censorship-resistant. However, if this is bitcoin's version of the "Cyprus moment," the present-day situation is vastly different from that in 2013. As cryptocurrencies have become more well-known to the public, albeit mostly negatively, the industry faces its most significant challenge yet - an escalated confrontation with the financial establishment.
Echoes of 2008 crisis as high-profile bank failures prompt government intervention
The birth of the Bitcoin blockchain is linked to the turbulence of the financial crisis of 2008-2009. On January 3, 2009, Satoshi Nakamoto forever marked that date with a headline from the London Times, reading "Chancellor on the brink of second bailout for banks" (referring to the UK's finance minister). The crisis exposed how our reliance on banks to facilitate our monetary and payment systems makes the entire economy vulnerable to discrepancies between banks' investments and liabilities, undermining their ability to honor deposits. The largest banks, whose interconnected credit exposure creates "systemic risk," exploited their "Too Big to Fail" status by making asymmetrical, high-return, risky investments. The crisis also highlighted how Wall Street (and other financial hubs) effectively hold our democracies hostage.
The recent collapse of three major banks, followed by the outflows of hundreds of regional banks, has led to the creation of a new backstop facility worth $2 trillion by the US Federal Reserve. In addition, Switzerland's central bank has rescued Credit Suisse with a whopping $54 billion. These events have reignited memories of the previous crisis. Last weekend, the Fed and the Federal Deposit Insurance Commission worked tirelessly to establish a funding plan to ensure that thousands of startups with deposits at Silicon Valley Bank could pay their employees on time this week. This reminded us of September 17, 2008, when, two days after the Lehman Brothers collapse, the Reserve Primary Fund, a cash reserve management tool for companies, "broke the buck." We were concerned that similar failures in short-term money market funds could cause widespread chaos in the economy's payment system for employees and commercial contractors.
What stands out here is not just the similarity, but also the cause and effect. SVB's collapse can be directly attributed to the policies implemented in response to the previous financial crisis. In 2009, when the US government was unable to agree on fiscal solutions to revive growth, the Fed launched a multi-year quantitative easing program, flooding Silicon Valley's venture funds with money that they invested in startups. These companies deposited their funds at SVB, which then invested in long-term US government bonds and mortgage-backed securities, which seemed like a conservative investment at the time. However, in January 2022, when the Fed acknowledged that its easy-monetary policies had led to sustained inflation, it started raising rates aggressively. This caused the bond market to plummet, resulting in massive losses for SVB, which had made the fatal mistake of not hedging its interest rate risk.
As panic grips smaller regional banks, depositors are flocking to Wall Street's too-big-to-fail institutions, making them even larger. This will place a select group of bankers in an unparalleled position as gatekeepers of our economy, centralizing power that is already exhibiting indications of overreaching.
The Challenges Faced by the Crypto Industry Amidst Banking Crisis
The fundamental reason behind Bitcoin's creation has always been to provide an alternative to the centralized fiat currency system run by central banks and private institutions by eliminating intermediaries from payments and enforcing a predictable issuance schedule. This approach aims to reduce the inherent vulnerabilities that have been highlighted by the recent events in the financial system. However, the initial reaction to these events has not been favorable for Bitcoin and the broader cryptocurrency community. The collapse of Silvergate Bank, one of the three high-profile banks to fail, was partially caused by its significant exposure to failing cryptocurrency firms. This led anti-crypto politicians, such as U.S. Senator Elizabeth Warren (D-Mass.), to call for strict measures against the industry, which contributed to a guilt-by-association effect on SVB, despite the bank's relatively low exposure to crypto.
The government's relationship with the gatekeeping financial institutions is being used either intentionally or indirectly to put pressure on the crypto industry, as seen with the closure of Signature Bank, another favored bank for crypto companies. Compliance officers at alternative banks are now rejecting these companies as they try to find new banking options. While the New York Department of Financial Services stated that Signature Bank's closure had nothing to do with crypto, and rather was due to a leadership crisis, people are questioning why a solvent bank was closed. Barney Frank, a board member at Signature, speculated in a New York Magazine interview that the New York financial regulator was using the bank as an example to warn others to "stay away from crypto." Reuters later reported that the FDIC is demanding that any potential buyer of Signature Bank gives up its crypto business, although the regulator later denied that report.
This method of blacklisting a lawful industry is an abuse of power. However, if the NYDFS is indeed engaging in such activities, possibly in collaboration with federal agencies, there is currently limited recourse available to crypto leaders. Moreover, stablecoins, which are crucial to the operations of fiat-to-crypto exchanges, have been affected by this issue. When Circle Financial revealed that some of the reserves supporting USDC were kept at Silicon Valley Bank, the stablecoin briefly lost its one-to-one parity with the dollar. Although the situation has been resolved, the closure of Signature Bank has resulted in Circle's inability to use its 24/7 Signet dollar-clearing system for redemptions, forcing the company to rely solely on the time-limited services of BNY Mellon, a Wall Street behemoth.
Bitcoin's Raison D'être in the Emerging Era of Digital Currencies
As Tatiana Koffman, an angel investor and author of the Myth of Money newsletter, pointed out in a CoinDesk OpEd, "Bitcoin is designed for this moment." As people lose faith in banks' ability to safeguard their funds, the argument for Bitcoin's self-custodial approach becomes more compelling. If the Federal Reserve is compelled to cut interest rates, which could weaken the dollar, Bitcoin's appeal will grow even stronger. (This likelihood was reinforced by news of an unexpected decline in U.S. inflation on Thursday.) I see this unfolding as a complex, multifaceted struggle for power, one that will ultimately drive governments to accelerate the adoption of new regulatory frameworks for the emerging era of digital currencies.
The recent bank failures highlight the importance of separating payments from the fragile fractional reserve banking system, which is exactly what fully reserved stablecoins aim to do. The recent issues with USDC will likely strengthen the argument for requiring stablecoin issuers to hold banking licenses and have access to the Fed's discount window, rather than relying on traditional banks for reserve storage. Custodia Bank attempted to do just that but was rejected by the Fed last month, which now seems like a misguided decision. Circle has also expressed a desire to become a bank.
If this approach gains support, what will be the reaction of traditional banks? They are unlikely to welcome the entry of new crypto players who may lure away their depositors, who provide a low-cost source of funding, and whose departure could trigger a larger banking crisis. Could governments resort to direct control through a central bank digital currency (CBDC)? CBDCs are thought to allow central banks to apply targeted interest rates, including negative interest rates, to encourage people to keep their savings in higher-paying traditional banks.
Governments face a dilemma as people may choose to shift their savings from national currencies to cryptocurrencies like Bitcoin, complicating their efforts to control the digitization of fiat money. Despite this, Bitcoin's use as a payment method may not necessarily compete with sovereign currencies, as larger economies will likely continue to use their national currencies. Bitcoin's role as an alternative hard-money option could still pressure governments to reassess their monetary policies, particularly as other countries like China gain an edge in digital currencies. While Bitcoin's effectiveness as a payment mechanism is still in question, some developing nations facing monetary outflows may follow El Salvador's example and adopt it as legal tender.