How the crypto industry reacts to recent bank bailouts

In its early days, crypto enthusiasm was fuelled by the promise to cut the rigged banking system out of the people’s basic need to exchange goods and funds. To some degree, it still is. But as digital assets become more and more intertwined with a larger financial market, this tension gradually fades away. 

The recent wave of partial bailouts of failed institutions such as Silvergate Bank, Signature Bank and Silicon Valley Bank (SVB) has not raised any concerns among the crypto community. Moreover, the United States Federal Reserve System came as a savior, at least in regard to USD Coin (USDC) issuer Circle, which kept a significant portion of its reserves in Signature Bank and SVB.

If the Fed decided to let the banks fail, we would probably have witnessed another sharp dip in the crypto market and not the optimistic resurgence of the last two weeks.

Does this mean that the crypto industry has come to a point where it is highly dependent on traditional banking and cannot contrapose itself as an alternative anymore? Is that kind of interconnectedness desirable for digital assets or should the industry create some distance from traditional finance (TradFi)?

Was it a bailout?

Technically, both SVB and Signature were bailed out, but economists are highlighting the major difference between the current solution and the U.S. government’s actions during the economic crisis in 2008.

“During the [2008] financial crisis, there were investors and owners of systemic large banks that were bailed out,” as Treasury Secretary Janet Yellen explained, but this time, it was depositors who got their back covered by the Deposit Insurance Fund, supplied by the banks, not taxpayers.

The Federal Deposit Insurance Corporation (FDIC) has effectively guaranteed all deposits at both banks beyond its normal limit of $250,000 per account. Still, it was only due to the FDIC’s support that Circle was able to withdraw the whole $3.3 billion deposit from the SVB and save USDC from further depegging.

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Still, isn’t there something odd about an industry with a strong anti-establishment and even anti-Fed background taking federal backing for granted, if not outright advocating for it?

Maybe not, as no speaker Cointelegraph has reached out to sees any ethical contradictions here. There’s an overlap between the crypto community and the startup community, so there’s naturally been a lot of support for the bank bailouts, Daniel Chong, CEO and co-founder at Harpie, explained:

“I personally don’t see a dissonance here: You can be a TradFi skeptic and still be in favor of startups having a way to continue operations and make payroll. We don’t need thousands of employees missing paychecks to prove that DeFi is a viable financial system.”

Although the DNA of the crypto community would oppose a bailout, Tony Petrov, chief legal officer at risk management platform Sumsub, told Cointelegraph that, sometimes, it is very important to at least attempt to save valuable institutions on the border of crypto and fiat — especially given the obvious scarcity of such institutions.

Of course, bailouts have gained a negative connotation not only within the crypto community. In some cases, a bailout looks like billionaire executives getting taxpayer-funded handouts in exchange for their own poor decisions. The philosophy of “too big to fail” is helping utterly ineffective and ill-governed banks to stay where they are, even if they don’t provide real value to the society where they exist. But, Petrov continued, it’s hard to deny that what happened to SVB, Silvergate and Signature was not a clear example of mismanagement solely on the side of the banks’ executives:

“After all, they invested in governmental notes, not in some shady digital coins, the value of which can hardly be predictable even within one day. Taking this topic very softly, it can be claimed that a part of the blame for the consequences should be borne by the U.S. government.”

Is crypto really to blame?

Although the panic among crypto investors following the FTX debacle played a role in depleting the bank’s crypto deposits, Signature’s problems were much more deep-rooted, Ahmed Ismail, CEO of liquidity aggregator Fluid, told Cointelegraph.

The bank served a tightly knit set of customers, including a group of startups and their investors. Ismail said that it aimed for rapid growth without adequately diversifying its business or clientele:

“Truth be told, businesses dealing with such tightly knit customer circles always face the risk of experiencing a domino effect.”

Petrov also doesn’t buy into the hypothesis that crypto is to blame for the banks’ collapse. Speaking to Cointelegraph, he highlighted the common problem of Silvergate and SVB, which was, ironically, their faith in U.S. Treasurys. By raising interest rates, the Federal Reserve naturally dropped their value, and the simultaneous turmoil at SVB provoked a bank run.

Some posit that it is the crypto industry itself whose financial stability is being undermined by interconnectedness with the banking system: more specifically, by the extreme limitations of that connection. The crypto market has been backed into a corner of the traditional banking system, Chong claimed.

Even before the collapse of Signature, SVB and Silvergate, there were only a handful of entities willing to bank crypto companies. It’s impossible for a crypto company to diversify its assets across many different institutions since there aren’t 20 banks that will have it:

“The idea that ‘crypto is too risky to bank’ has become a self-fulfilling prophecy. The few institutions willing to bank with crypto companies face very high demand from a market that has nowhere else to go. They become ‘crypto banks’ by default, and all the risks inherent in these fast-moving markets end up concentrated in a few institutions.”

What is to be done?

What can the crypto industry do to escape the sudden dangers of relying upon banks? Not much. The paradox is obvious: Cryptocurrencies won’t need banks if they somehow become the major means of exchange and accumulation, but the only way for them to get to this utopian point lies through their interchangeability with fiat money. To Petrov, because of that exchangeability demand, building a fence against TradFi looks like a counterintuitive idea.

An independent world of crypto remains a great libertarian promise, but nothing more, he explained, “In the background of the meltdown of three huge crypto-friendly banks, we saw the surge of BTC for more than $8,000 in 10 days. This is evidence that there is no distance between fiat and crypto: They communicate as the venous circuit and the arterial circuit in a human organism.”

Oliver Chapman, CEO of supply chain specialists OCI, also doesn’t see how crypto can escape TradFi. All in all, it is TradFi that has stepped in to support a bank that was crucial for the crypto industry, he told Cointelegraph. 

The crypto industry may or may not distance itself from TradFi, but if it does, it will either be tiny and unimportant or pose a systemic risk, Chapman said, stating, “Finance is either important or we return to the caves. And whether that finance is traditional, crypto or a combination, when things go wrong, a systematic crisis that could precipitate a disastrous global recession remains a danger.”

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The crypto economy can continue improving its performance without directly conflicting with banks and similar traditional finance institutions, Ismail stated. It has already made finance more accessible and cost-optimized by cutting out cost-bearing intermediaries. Moreover, using cryptography and smart contracts in decentralized finance has enhanced the system’s security without compromising efficiency. But there’s nothing inevitable about the conflict between the two systems, Ismail said:

“I don’t see why traditional finance and the crypto economy should be pitted against each other. Both can coexist without the cost of the other.”

Chong doesn’t take this conviction for granted. In his opinion, we’re going to see a lot of value moving on-chain exactly as a result of such collapses within the traditional finance system. The question is whether the crypto market, with its own wave of devastating collapses in 2022, is ready to serve as a safe alternative to banks. In order to be the alternative to TradFi, the crypto community needs to come up with some standards for how to manage corporate assets. 

Chong added, “In the current environment, you need to be a crypto-native engineer to have any chance of keeping your blockchain assets secure. That’s not scalable.”