Regulators forced to play whack-a-mole with crypto-friendly banks

The case of Customers Bank shows the bold will always create opportunity where others fear to tread. The Big 4 audit firms are never far behind .

New things coming along don't take away the opportunities. What gives you opportunities is other people doing dumb things.

Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.

Warren Buffett

Everyone can see we're together
As we walk on by (and)
And we fly just like birds of a feather
I won't tell no lie (all)

Sister Sledge

The collapse of crypto-friendly banks Silvergate Capital Corp. and Signature Bank in March left Customers Bank — a West Reading, PA - based bank — as one of the few FDIC-insured institutions that would facilitate transfers of crypto to US dollars.

That's what Yueqi Yang wrote for Bloomberg News on July 17.

The lender, ranked the 81st-largest U.S. bank by assets, is now at the forefront of an industry battered by blowups, scrutinized by regulators and shunned by mainstream lenders — a very different spot from almost two years ago, when Bitcoin was at a record high and investors were piling in.

Back then, Customers Bank chief executive officer Sam Sidhu touted his firm’s crypto ambitions. Today, the bank is putting a cap on crypto-related deposits and Sidhu says the assets are just one small piece of a broader plan to expand the bank’s payments business.

There are two myths that continue to be perpetuated by self-interested parties who prefer to deflect from facts that say otherwise:

1) There is no crypto contagion to the traditional banking system.

2) The Big 4 audit firms — Deloitte, EY, KPMG, and PwC — do not want to risk their reputations by doing business with crypto firms.

Myth 1: There is no crypto contagion to the traditional banking system.

Customers Bank now does business, according to the Bloomberg article, with some of the biggest names in crypto.

Circle Internet Financial, the stablecoin giant that issues USD Coin, uses Customers’ payments platform to process U.S. dollars associated with the creation and redemption of its stablecoin. That in turn drives many of Circle’s clients to join Customers’ platform, creating a so-called network effect — the more companies that join the platform, the more attractive and useful it becomes.

Other Customers clients include the biggest U.S. crypto exchange, Coinbase Global Inc., as well as stablecoin issuer Paxos Trust Co., trading firm GSR and custodians Anchorage Digital and BitGo.

So, like a gerbil moving through a boa constrictor, the demise of Silvergate and Signature didn't put the kibosh on traditional banks doing business with crypto-adjacent customers. Instead it pushed the crypto activity through the snake to another waiting-in-the-wings, ambitious, FDIC-insured regional bank.

That's despite all the early talk about banks turning a cold shoulder to crypto and the ongoing claim that the SEC's "crypto crackdown" is about to kill the industry all together.

In December of 2022, in the aftermath of the FTX failure a month earlier, an American Economic Liberties Project report said that the SEC's Gary Gensler, “Kept crypto mostly out of the banking system".

It's the mostly that should stick in their throat, I wrote.

National banks overseen by the OCC aren’t allowed to get involved in crypto-related activities without its approval but the OCC has given its approval more than once. Many of these banks are publicly traded and file financials with the SEC.  

The AELP report blames "lax regulatory choices from the OCC and the Federal Reserve" for the growth in crypto banking and custody options — despite the fact that almost all the banks involved with crypto are listed issuers whose financial statements are overseen by the SEC. The AELP report says they are "isolated and unlikely to foster a banking crisis".

In the Wall Street Journal in February 2023 the narrative that any banks bold enough to dabble in crypto were now chastened continued:

Banks are backing away from crypto companies, spooked by a regulatory crackdown that threatens to sever digital currencies from the real-world financial system. 

Banking regulators are raising concerns about banks’ involvement with crypto clients following last year’s blowup of Sam Bankman-Fried’s FTX. The Securities and Exchange Commission is aggressively pursuing the industry’s bigger players in a crackdown that threatens to narrow their reach. That move has alarmed bankers who don’t want to do business with customers in the SEC’s crosshairs, people familiar with the matter said. 

Now bankers are re-evaluating any exposure to the crypto sector, no matter how small, according to people familiar with their thinking. The few smaller banks that got deep into crypto are reducing their exposure to the market or cutting ties altogether. Banks that kept their distance from crypto are trying even harder to stay away, closing accounts and shunning customers with potential connections to the industry.

In March 2023, the one-after-another bank failures occurred, starting with Silvergate. But it wasn't just Silvergate and Signature that had crypto exposure:

That largesse extended to the crypto economy, one that many of Silicon Valley Bank’s most important customers such as Andreessen Horowitz's 16z and Peter Thiel's Founders Fund heavily support. In Feb 2021, Coindesk reported that banking services were so hard for cryptocurrency businesses to come by in the early days that pre-IPO Coinbase gave Silicon Valley Bank (SVB) stock warrants in 2014. This was part of an agreement allowing Coinbase to send and receive U.S. dollars through the banking system.

The disclosure in Coinbase's S-1 filing describes a warrant that gave Silicon Valley Bank the right to buy more than 400,000 class B shares of common stock at a little over $1 per share.