Odd Lots - Silvergate CEO Alan Lane On the Business of Stablecoin

Episode Date: June 2, 2022

The collapse of the Terra/Luna experiment has brought fresh attention to stablecoins, and the different flavors they come in. Some are fully backed with standard financial assets. Others are backed by crypto. Others aren't really backed at all. But why the interest in stablecoins to begin with? Why so much enthusiasm and investment for cryptocurrencies that aren't even designed to go up? On this episode of the podcast, we speak with Alan Lane. Alan is the CEO of Silvergate Bank, which is one of the most important financial institutions in crypto, providing banking services to many of the big players. It's also active in the stablecoin space, providing infrastructure for creating and redeeming them. Among other things, it purchased the assets of Diem, which was Facebook's aborted stablecoin project. We talk with Alan about why there's so much money in the space, and how the industry might be properly regulated.  See omnystudio.com/listener for privacy information.

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Whether you're storing a little or a lot, now's the time to make your move. Visit XYZ Storage.ca. Hello and welcome to another episode. of the Oddlots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. So Tracy, you know, we recently had the collapse of the stable coin UST and the total disaster of that didn't turn out to be a particularly stable coin in the end. You're not going to say it. You're not going to say unstable coin. You're so close, so close to saying the cliche. Okay, yes. So Tara slash Luna collapsed. And that kicked off. I would say soul searching. Maybe not soul searching.

Yeah, I think soul searching is a fine word. Well, a vast amount of criticism of the stablecoin space. And we saw some other stable coins, notably tether, start to wobble a bit, although it looks like it's gotten back closer to its peg since all of this happened. But lots of people asking tough questions about the space. Are stable coins sustainable? Are they inherently sustainable? Are they inherently sustainable? to some sort of bank run-like phenomenon. And then secondly, is this whole Terraluna collapse going to expose the sector to more regulation? Is there going to be even more attention trained on this?

Yeah, right. Because there are different models of stable coins. So this is really important. So there are stable coins where an issuer has a dollar's equivalent of assets in a regulated bank. There are stable coins in which the issuer has, in theory, a dollar or more than a dollar, worth of crypto assets held up in some smart contract. And then there are these so-called algorithmic stable coins in which, I don't know, through magic, they don't really seem to work, but they keep trying.

But there's like somehow the price is supposed to just stay there even without the money. But the point is, if you sell something that is nominally supposed to be worth a dollar, and it doesn't stay at a dollar, then regulators are going to get interested. And, of course, we saw in the financial crisis that one of this sort of low-co, a source of instability, loci, was money market mutual funds, which were supposed to stay at a dollar and didn't, the reserve fund. And so any time you have something that's supposed to hold a dollar or supposed to be stable and is not, this is a major source of regulatory interest regardless of what the model is. That's right. And regulators are well aware that when you have something that's supposed to be worth a dollar, if it dips below a dollar like reserve,

primary did back in 2008, it can actually have massive consequences for the rest of the financial system. You get a contagion effect. And I think this is partially why they're worried about the space. But the other thing I would say is, this is why when people say, oh, Tara Luna, you should have known better. This was a terrible, you know, volatile asset. It's like, well, the marketing actually matters here. If you say this thing is always going to be worth a dollar, yes, obviously people can do due diligence and decide for themselves whether or not that's true. But you're putting it forth as a stable $1 pegged asset, and that comes with some sort of responsibility that regulators might well want to enforce. Absolutely. Like that to me is the key thing. Like, okay, yes, at some level, right,

people can learn about the smart contract risk and they can learn about, you know, what theoretically is and isn't back into coin. But if you call something a stable coin that it falls, that seems like a problem. So we need to learn more about the space. And the other question I have, like, why is it growing? I thought the whole point of crypto was to make a lot of money and have the number go up. So why the attraction to a coin that doesn't go up is another big. Well, also to get away from Fiat dollars, right? And instead of getting away from it, it seems like we've just created the shadow banking system, almost like the euro dollar market, just to create more dollars that are pegged to dollars. Anyway, I have so many questions.

Let's get into it. I did too. So I'm really excited about our guest because he has a great position within this world to understand the sort of intersection of crypto and traditional banking, which is kind of what a stable coin is. It is this attempt to sort of bridge. Okay, you have the U.S. dollar and you have crypto and you sort of make a crypto version of the U.S. dollar. We're going to be talking to someone who is a great viewpoint on that. We're going to be speaking with Ellen Lane. He's the CEO of Silvergate Bank. which is a bank that has kind of become the bank that banks crypto. It's been banking and working with crypto companies since 2014. It is active in the sort of like plumbing the backside of the stablecoin space. So we're going to get all into the business of stablecoins. So Ellen, thank you so much for joining us. Yeah, thank you for the opportunity. It's great to be here with both of you.

Ellen, why are people so excited about stablecoins? I thought the whole point of cryptocurrency was like a number, shooting up to the moon. What's so exciting about a coin that just stays flat at the U.S. dollar? Yeah. Yeah, you're referencing the number go up. Yeah. What's the point of a coin that doesn't go up? Yeah, well, you know, as a regulated financial institution, Silvergate is a California state chartered bank. We are a member of the Federal Reserve. Our deposits are insured by the FDIC. And so we're very interested in the stability of the U.S. dollar and making sure that anytime any of our customers show up, they, you know, that they can get their dollars back out. And so you're absolutely

right. I heard in your introductory comments that we've been banking this ecosystem since January of 2014, which is an important data point because back then it was Bitcoin only. And so we entered the space really focused on this new digital asset called Bitcoin and some of the companies that were being formed at the time to provide services to this budding Bitcoin space. And many of them were struggling to find and maintain bank accounts. And so that was really where we started. We've obviously evolved quite a bit over the last eight years and happy to talk a little bit about that. But I don't want to derail the stable coin conversation. Well, I mean, I'll take you up on both those topics. So, you know, a regulated bank interested in the stability of the U.S. dollar and presumably, you know,

relatively interested in kind of boring investments. You got into crypto in 2014 when stablecoins didn't really exist. And you've since evolved from becoming just a bank for crypto-related businesses to one that is more intricately involved in the stablecoin business. Can you explain that transition to us? And what exactly is the opportunity there for you when it comes to stable coins? Let's go back briefly to our entrance into the space. And it was really preceded by intellectual curiosity on my behalf personally. I was looking at Bitcoin in 2013.

And this meme was with Bitcoin, you could be your own bank. And being a career banker, I thought that was interesting. And so as I went down the Bitcoin rabbit hole, as they say back in 2013, I was really intrigued by this concept of the fact that Bitcoin had a fixed supply. And, you know, we're talking a little bit here about the stability of the U.S. dollar. And we know that the Fed's mandate is to try to maintain inflation around two. You know, there's obviously we're quite a bit above that right now. But even with just that mandate, the fact that inflation at a target rate of 2% means that by definition, even though I mentioned at the outset that we're interested in the stability of the U.S. dollar, the fact is

U.S. dollar is destined to go down in value if the Fed hits their target by 2% a year. And so I fell down the Bitcoin rabbit hole. I was intrigued by it. I didn't buy as much as I should of and that's probably every bitcoins, there you go. That's probably every bitcoins, you know, thought, no matter when you get in. But the fact of the matter is, once we got into the ecosystem and we were trying to help our customers, so the first thing we did, Tracy, is we were just a bank willing to talk to these new companies. And I should mention right up front, Silvergate is institutionally focused. So we do not bank consumers directly. So this is an important distinction, because many of our customers provide services to consumers, but we are an institutionally focused bank.

And so we were opening bank accounts for businesses who were providing services to the Bitcoin ecosystem. And what did that look like back in 2014? Well, it looked like Genesis, which at the time was still called Second Market. They were enabling some of their customers to, you know, to buy and sell Bitcoin. And we went deep on this early. So, you know, know, because we needed to satisfy ourselves and our regulators that we knew what was the use of proceeds. You know, what was this money being used for? These businesses are deemed to be money service businesses. And so what we would do is when Genesis then called Second Market would actually try to transact on behalf of a customer. So one of their customers wanted to buy or sell Bitcoin. And that meant that they were sending a wire transfer across our platform.

we asked at the time, okay, give us the Bitcoin address, you know, for this transaction. And what we wanted to see on the blockchain was if someone was sent in $100,000 to buy or sell Bitcoin, we wanted to go out to the blockchain and see that there was, in fact, a transaction that represented $100,000 of value. And I think at the time, second market was somewhat amazed that this bank in Southern California was actually asking, you know, for blockchain addresses. And I think we have a pretty deep understanding of this ecosystem to now get to the point of the story around Stablecoin, you first have to understand what is Silvergate known for today. And that is a platform.

It's a global payments platform that is referred to as the SEN, which is an acronym S-E-N. It stands for the Silvergate Exchange Network. And what that is is it is a two-sided network where we connect. digital asset exchange platforms such as Coinbase and Gemini and Crackin and FTCS and as soon as I start naming them, I'm worried I'm going to leave somebody out. We've got all of them, all of the major ones, anybody that is serious about regulation, and that's an important distinction, because they have to satisfy not only their own legal and regulatory requirements, but then we have to verify that their compliance programs

are sound. So that's one side of the network. And then on the other side of the network is institutional investors, other folks who are providing access to Bitcoin and other digital assets, and we connect them across our platform so that they can interact 24 hours a day, seven days a week. It is only Fiat currency, though, and that's another important distinction, especially as we move to the stablecoin topic, because our customers, are dealing with U.S. dollars and now Euros, we launched the EuroS.N. platform back in February so that we can provide this service over in Europe as well. But it is a 24-7 API-enabled connection so that our customers can move U.S. dollars amongst themselves around the ecosystem

any time of the day or night. We launched this back in 2017, and it was really a game changer for the industry and for Silvergate, because we were the first bank in the world to actually bring this, the legacy banking system that only operates 40 hours a week Monday through Friday into the 24-7 digital asset market that trades around the clock around the world. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real.

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Go to FactorMeals.C.A. and use code fit. That's 11 meals, free shipping, and free sides for life. but only with the code fit at factormeals.ca. Factor, Canada's number one ready-to-eat meal delivery service. So can you describe how stablecoin issuers use your services directly? Where are you in the ecosystem? Because obviously, as you mentioned, you have a lot of clients who are in the broader crypto space, FTX and all these exchanges and so forth.

How would a stable coin issuer, what value do they get from Silvergate? Yep. So they use the SEN and our API for the important, you know, that on-ramp and off-ramp. I've often tried to just describe what we do as, hey, we are the regulated on-ramp from the U.S. dollar and other fiat currencies into the Bitcoin and digital asset market. And then likewise, we are the off-ramp from that, the digital asset market, back into fiat currency. And the way that's done, and so let's talk about the stable coins, the stable coin issuers who use our platform. So they are all of the regulated US dollar backed stable coin issuers. And by that distinction, I heard in your opening remarks, you were distinguishing between the different types of stable coins. The dollar backed ones are the only ones we back.

So we don't bank bank the algorithmic stable coin offerings, nor do we, you know, these other, you know, stable coins that are maybe collateralized by other digital assets. Those are those all, they don't need a U.S. dollar bank because they're not backed by U.S. dollars. So by definition. But importantly, we also don't bank Tether. And believe it or not, we had the opportunity to work with Tether very early on. but because they weren't inside the United States, and, you know, again, we are very serious about

regulation. And so we looked at it and we thought, you know, this is an interesting idea. Tether was launched before Circle, launched the U.S.D.C. So we thought, yeah, gosh, that's an interesting idea. But they're offshore. We can't really get our hands around, you know, their regulatory status in the United States. And so we were not able to bank them back then. This was back in 2017, nor do we bank them today. So that's what we don't do. What we do is for USDC, for the Pax dollar, which is issued by Paxos, for the Gemini dollar issued by Gemini, and for True USDA, they use the San and our API for the minting and

burning of their tokens. So those tokens are issued. a dollar hits their Silvergate bank account. And it's all programmatic. And so if somebody wants to purchase USDC from Circle, what they would do is they would send dollars into Circle's bank account at Silvergate. And when those dollars hit the bank account, then at that moment, there is an API call from Silvergate to Circle.

that says we just received X amount of dollars from this customer. And at that point, Circle knows we have the dollars in our possession. So they turn around and they mint the USDC token and send it to the wallet address of that, that institution that is looking to purchase the USDC. And then the same thing happens in reverse. So if someone wants to redeem their USDC and go back to US dollars, they send the USDC to the wallet at Circle. Circle at that point, once they have possession of the USDA,

they then send an instruction to us via API, and we then in turn will send the dollars back to that prior USDC token holder. So can I ask a step back question, a broader question about the space? Is there an irony here that a lot of crypto is sold on the basis that, you know, you can have financial assets that sit outside of the traditional financial system. And you mentioned one of the things that got you interested in crypto in the first place was this idea of, you know, be your own bank with Bitcoin. But, you know, fast forward some years and you are a bank that deals in the crypto space. Isn't there a fundamental tension there about having a financial system outside of traditional regulation,

but still needing to be plugged into a regulated financial entity? Yeah. So, again, an important distinction, though, would be that these entities that we're banking aren't operating outside of regulation. So that would be the first thing I would say. But to the broader kind of fundamental question, I distinctly remember when I was talking with our team internally about this back in 2013. and, you know, and this meme was be your own bank.

And my thought process was, well, if this takes off, you know, it's going to take years. It's going to take decades. I've been in banking for 40 years. So I've seen all the different things. I mean, I was there right as Reg Q was being repealed, which limited the amount of interest that you could pay on deposits. I was there when the first ATMs were being installed. So I've seen all of this quote. unquote innovation. Bitcoin is the true innovation, in my opinion, but it's not going to displace

government's sovereign government's desire to issue their own currencies. And so I view Bitcoin as, you know, you guys are very familiar with the mean digital gold. You know, it is a way to save a portion of your wealth. And I think that we still need to operate in the financial world with fiat currencies, the world that we actually live in. And just like some people might try to, you know, try to save some of their wealth in gold or in some other, you know, in stocks and bonds, et cetera. I think Bitcoin is certainly an alternative, but I don't think it's going to replace the dollar. And so I actually think Silvergate is perfectly positioned to, you know, kind of have a foot in, you know, in both ecosystems. So you're the owner of,

the assets that were DM. So Facebook, for a few years at least, I think starting in 2018, they tried to get their own stable coin off the ground. It's going to be sort of a global thing. It just never really worked. Why couldn't, what was the problem from your view? Why didn't that work? And what are the asset, what constitutes the assets that were left over that you've acquired? Why it didn't work. I, you know, unfortunately, I think it's because it was Facebook. You know, I will say early on, I think, you know, they, they not only, you know, kind of raised the ire of the U.S. government, but of, you know, a lot of governments when they, when they announced that they were going to issue this and make it a, you know, backed by a basket of currencies. So it's like, well, let's let's not only, you know, upset the U.S. you know, the U.S. government, but let's upset, you know, all of these other sovereign nations who are issuing their own currencies and let's make it a business. basket, you know, so, so I, I think they quickly realized that that it needed to be backed by a single currency. Unfortunately, by that time, you know, I think they were just in the crosshairs. And no matter

what they did, you know, they tried to move offshore. You know, they were a Swiss entity for a while trying to issue a U.S. dollar back token that, you know, if you just stop and think about what I just said, you know, that's, you know, that's going to be problematic. A, a, a, a, a, a, a, you know, a, a Swiss entity issuing a US dollar back token. And so, you know, there are a lot of challenges. But at the end of the day, what we saw is the opportunity, and I should mention, we were not involved

with Facebook at all during any of that. We ended up coming on the scenes late. So they had, as you'll know, just remind you that they started out as Libra. They then switched the name to DM. They then moved to, at some point in that, they moved from the US. to Switzerland.

And during that entire time, we at Silvergate were looking at the feasibility of issuing our own stable coin. So we were already banking USC and some of the other early entrance. And we were looking at the pros and cons of whether or not we should issue our own. Why would we do that? Well, back at that time, the thought process was, well, we've got this send, the Silvergate Exchange networks. So a lot of our customers are using the send to transact dollars 24-7, but that's not on a blockchain.

It doesn't, candidly, it doesn't need to be to do an intramank transfer. But if they want to take their dollars outside of Silvergate, well, then oftentimes what they were doing was they were starting on the send. They were then buying a, you know, USDA, and then taking that USDC to places where they didn't have a Silvergate bank. account, for instance. And so we started thinking about whether or not we should issue our own. We did the legal permissibility analysis. We believe that it's legally permissible for us to issue a stable coin. We have not actually heard anything to the contrary and all the conversations we've had with our regulators. So we do believe it is legally permissible. And we were getting ready to, as they say, go to Washington and talk about this back in March of 2020, right, as the

pandemic hit. And so obviously everybody's priorities shifted a little bit. And so we, we cooled our heels in the first and second quarter of 2020, but we were still working on the idea. And it was late 2020 where we actually were approached by the DM Association. And they wanted to talk with us because they were familiar with our ability to mint and burn tokens. And at the time, they were working with four other banks. I don't know who those banks were, but four other large banks. And the concept was these four banks were going to hold the reserves, but, you know, each of them was going to hold 25% of the dollars backing these tokens. So you're going to have this, this broad array of banks holding the reserves. But none of those banks really had the capability that

Silvergate has developed to be able to interact with the technology minting and burning and all of that. So what, you know, what we looked at at that time was, well, this is a completely separate use case from what we had been contemplating. You know, to go back, you know, to what I was saying a minute ago, we were contemplating potentially issuing a stable coin because we saw the value in helping our customers have a dollar token that could be used in the crypto ecosystem. But what the DM Association was trying to do was really take this concept of a tokenized dollar to be able to use it for commerce, for payments, for remittance.

you know, not cryptocurrency trading. And that was fascinating to us. And again, right at that intersection of, hey, we're a bank. Banks participate in payment systems. And wouldn't this, wouldn't this be interesting to be able to unlock the ability for people all over the world to have a tokenized dollar in an app on their phone that they could use to pay for things? And that would be interoperable. And so that was our thesis going in. And so we said, yeah, we'd absolutely like to be a of this as we worked with the DM Association over the first six months of 2021, it got to the point where they abandoned that multi-bank kind of approach. And we agreed and we announced in May of last year, May of 2021, that Silvergate was going to be the exclusive issuer of the DM US dollar.

And so that was, you know, that was at the time a big deal for us. And obviously we thought that we thought that we saw a path to us participating and partnering with them to issue the DMUSD. Unfortunately, as is now somewhat ancient history, there's a president's working group of regulators. It's called the president's working group. It's the U.S. Treasury, the Federal Reserve, the SEC and the CFTC. And they've been looking at this question of stable coins. They were doing some work last year to address the potential regulations. for stable coins. And so we were strongly encouraged to wait and to not launch last summer and to wait for that work to be done. And that report was issued on November 1st of last year.

What's it been like generally to work with regulators and, you know, people like the Federal Reserve? Because my my general impression of it when it comes to the crypto space is that often it's sort of like it's better to just do it without asking permission. And you see, no, but on Honestly, when you apply to the regulators officially, you tend to get rejected, whereas if you go out and do it, I mean, I'm thinking specifically of Tether, if you go out and do it, like often you just kind of get away with it. So I'm curious what those conversations are actually like. Yeah, Tracy, it's a, it's a fair question. And, you know, at times some of our investors, you know, have asked us the same question. Well, why don't you just, you know, watch something. Well, I think there's a big difference between a regulated bank that is already operating under the supervision of, you know, and under the authority of these regulators, these different regulatory agencies versus a tech startup that's going to spin something up and launch it into the market. But to your question of what's it been like, you know, our regulators have really come up the learning curve. I mean, we've been doing this now, as I mentioned, for eight years. And just to go back for just a second,

in 2014, we did a version of what you're suggesting, obviously at a very small scale, but we started opening accounts for these customers such as second market at the time. But we were confident that we understood how the existing regulations applied to that activity. So, you know, there had been FinCEN guidance issued in 2013. There was clear. your guidance for how a bank should interact with the money service business. So, but what we did was, so we applied these existing regulation to the activity that these customers were engaging in. And then we invited our regulators into our offices in the summer of 2014. And we gave them a Bitcoin tutorial, not to be unfair to them, but Bitcoin was brand new. And in 2014, when I asked

the question, so it was the state banking department in the Fed, and I asked the question, and I asked the question if they had heard of Bitcoin. And they were thinking about it, well, is that kind of like banking marijuana companies? You know, and so it was kind of all, you know, it was very unclear. But I could show you the presentation. It was like an eight page or 14 page presentation. This is what Bitcoin is. And these are the types of companies that are being formed. This is the FinCEN Guidance that came out last year. This is how we're thinking about banking the companies. We engaged very early with our regulators. And then over the last eight years, they've been in at least annually.

And most years, they've come in for an interim visit to kind of look and make sure that, you know, that we're doing everything appropriately. So our regulators have had a long time to go to school on the different things that we're doing. I'll just mention one other thing off topic. But we also offer loans collateralized by Bitcoin. And that was another path that we went down with our regulators, starting back in 2019, where we did the legal analysis. You know, we satisfied ourselves that it was permissible to lend against Bitcoin as collateral. We then engaged with our regulators.

We told them how we were thinking about doing it, all the risk mitigants that we had in place. We launched a pilot in early 2020, ran that pilot for several months, and then came out of the pilot now back then in, 2020. And we sit here today now with over a billion dollars in send leverage commitments. We call the product send leverage. And so that's another example of engaging with our regulators. And so Tracy, they understand this technology. They have bigger questions. So when we get back to DM, and I want to tie in the last part of your question, which was, okay, we bought these assets, What did we buy and what do we plan to do with it? So when the president's working group report was issued on November 1st of last year,

it clearly stated a preference for stable coins to be inside the banking system. So we're a bank, so we can check that box. The other thing that it clearly said was there was a desire to see that these payment networks were essentially not, you know, kind of controlled by, I forget the terminology that was used, but I'll just say big tech, okay? You know, we can go back and look at the actual language. And so look at, we looked at that guidance and then, you know, kind of breathed the sigh of relief that we had not gone ahead and launched. So to your point, Tracy, they didn't tell us, no, you can't do this, you know, in the summer. What they, they strongly encouraged us to wait until this

guidance came out. And once the guidance was out, it was pretty clear that, man, if we had launched with DM, we would have then been operating a stable coin that was in direct contravention of what the regulatory guidance was. And so we were glad that we hadn't moved forward at the time. And now, to your question, so what did we buy? So at the same time that we read the report, the DM folks read the report, they were looking at that and we call them up and we said, said, well, what do you guys think? And they said, yeah, we think we're going to, we're going to pause this effort. Looks like we're kind of dead in the water. My words, not theirs. And so we're going to engage strategic advisors to help us figure out what to do with, you know, with this. Because the one

thing I can say with confidence is, you know, they didn't spend Facebook, who was the initiator of this. They didn't spend two or three years and, you know, millions and millions of dollars with some of the best software engineers in the world, they didn't build this technology to turn around and sell it to somebody else. But yet, that's where they found themselves. And so we looked at that. We had been ready to go. We had done all that work to integrate with them.

And so we looked at the tech and we said, you know, this is actually purpose built for payments. They had some of the best technologists in the world building it. They had a lot of digital first retail platforms. ready to engage with it, to start offering it to their retail customers. And so let's see if we can acquire this technology. And then we'll just come back to where we were a couple years ago and we'll issue it ourselves.

And so that's what we bought in January. So we bought the protocol itself, which is open source. And some folks have said, well, gosh, what did you really buy? Because it isn't this open source? It's absolutely open source. And we think it needs to be. People need to be able to look. at the blockchain, just as we looked at the blockchain back in 2014 when we were looking at

Bitcoin transactions because we wanted to verify that leg of the transaction. So it's open source, but importantly, there are proprietary regulatory compliance elements that have been built on top of it to satisfy that the know-your customer, the anti-money laundering, the BSA requirements. So buying all of that together in furtherance of then us being able to issue our own stable coin and again for the use of payments and remittance and not for a cryptocurrency use case. Eating well shouldn't be complicated, but somehow it turns into recipes, prep, clean up, and half your Sunday gone. Factors solves all that. These are fresh, ready to eat meals designed by dietitians, delivered to your door, and ready in just minutes. No prep, no cleanup, no excuses.

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clean, secure units are ready when you are. Students heading home or switching apartments between semesters save 50% off your first three months. Make space for what's next. Visit xyzstorage.ca. So I want to ask another regulatory question, which is, what, in your view, should back stable coins? Should they be entirely, say, short-term treasuries, like one-to-one? Because this is a big question.

And then also, if there is going to be sort of non-perfectly liquid assets, like maybe there's some commercial paper, or maybe there's some more longer-dated treasuries, is there a risk of contagion to the broader financial system if in a cryptocurrency, crash and people want to pull out, stable coin issuers have to liquidate some of their assets rapidly. Like, I know you're not in the business of actually holding them because you talk the assets, because you're in the API, the minting and burning of stable coins. Nonetheless, I want to get your take on if I buy a stable coin, what should I expect in terms of what's backing it? And then the sort of like potential spillover effects of crypto volatility into assets

that don't necessarily have that, you know, into the, yeah, into the broader financial assets. Yep, yep, great question. And we think a lot about this because, candidly, we treat the SEN and all, you know, so we have, I don't think I've mentioned this yet, but we have over 1,500 institutional customers at Silvergate in this initiative who are using the SEND every day. And as an example, in the first quarter this year, we had $142 billion. So we're about a $15, 16 billion bank in terms of total assets. We had $142 billion move across the SEN in the first quarter of this year alone. That was actually down quite a bit from the fourth quarter.

And as you know, cryptocurrency trading was down. But in the fourth quarter, we had over $200 billion. And so what that means is that we have to stay liquid. there's different definitions of liquidity, right? The way we define it is that we have a very large investment securities portfolio. So on 15 billion in assets, we probably have 12 billion in investment securities. I already mentioned, you know, with the collateralized Bitcoin lending, you know, we have about a billion dollars in commitments there.

But the overwhelming majority of our balance sheet is in, investment securities. Now, they're not all treasuries, but, but they, importantly, they all trade actively, you know, the types of securities that we buy as a bank, we can, we can trade out of those on any given day. Obviously, if they're longer in duration and interest rates have gone up, then, you know, we're going to have to take a haircut. But we do look at at this, and this is one of the reasons we don't, we don't pay interest on our deposits and we don't and we actually encourage our customers to only keep as much at Silvergate as that they need for for their for their trading and investing activities we you know you you mentioned joe that you know that we don't hold all the reserves

for usdc for instance usdc is over 50 billion dollars we're only a 15 billion dollar bank and we have 1500 customers so obviously yeah we don't have the majority of of those dollars, they are spread elsewhere in the banking system. And there is, you know, there are other banks that have obviously since we got into the space, there are other banks that are banking this, this crypto space. And candidly, I think what they're doing with the deposits, and this is not criticism, this is just a factual statement. They are doing what we did back in 2014, which we looked at this and we thought, heck, this is a potential source of deposits. Yeah. our lending activities. And so if you were to look at some of the other banks that are banking the

space and what are they doing with the deposits, I think they're primarily using those in some of their lending operations. And again, their banks, that's what they do. We have decided that the industry is relying on us as critical infrastructure to provide liquidity. And when, you know, when Terra was melting down, obviously we didn't have any exposure whatsoever to Terra, but that contagion, if you will, that was spreading throughout the ecosystem and causing people to go to cash or go to stablecoin or, you know, go to a dollar back stable coin, you know, you can imagine that we might have seen heightened activity across our platform. And the industry relies on us for that critical function. So can you talk a little bit more about risk management

and specifically in the context of this sort of one-way risk, which is basically what we saw over the past month or so when Tara Luna collapsed, which is that you had bonds and stocks falling. You had all sorts of crypto and tokens falling at the same time. There was lots of anecdotes about people potentially having to liquidate positions in order to pay off collateral on margin that they needed to pay because of the volatility. How do you actually handle that risk? Because it feels like with a lot of crypto, it's basically crypto exposure kind of squared and also pegged to occasionally tied into stocks and bonds. So it feels like it feeds on itself at certain times. What I can say about the way we're set up at Silvergate is because we are not the bank that is holding like the reserves. We technically don't, you know, we don't want to be their primary bank

in the sense that, you know, where I've spent most of my career as a business banker, you know, the idea is, well, gosh, let's get the, let's get the operating deposits, let's make them alone, you know, let's get the full relationship. We take a very narrow view here, which is, you know, don't keep with us excess deposits that are needed for other things because we are primarily a liquidity source. And so what that means, Tracy, is that when there's this type of activity, we see a lot of money going through our bank, but we actually see our deposits. I talked about this on a investor call last week. I referred folks on that call back to our earnings transcript. at the end of the first quarter of 2020.

If you remember back at that time, you know, pandemic hit, markets were crazy. You know, Bitcoin sold off. You know, the crypto markets were selling off as well. And what we saw back at that time was a surge in our deposits. And we reported on that because it was quarter end. We said, look, our deposits are elevated at quarter end. We believe that's temporary. And by the time we released our earnings, the third week of April,

we're already seeing deposits kind of normalized. and we reported on that fact. But critically, we are this critical, you know, piece of infrastructure where folks, as they're exiting the ecosystem or wanting to go to cash, those dollars pass through Silvergate and then end up wherever they're going to put them. Sometimes it just ends up at USC, in which case those dollars aren't going to sit at Silvergate.

They're going to sit in reserve, but they might pass through us on their way. One of the things, I mean, we've been managing liquidity this way since we launched the Senate in 2017. Back at that time, believe it or not, we were a $2 billion bank and we had a billion dollars in crypto-related deposits. We were holding almost all of that at the time at the Federal Reserve because when you're going through these times of liquidity and stress, you want to make sure that you're not investing those funds into something that's more long term because you don't know how sticky it's going to be. I just want to go back to this point

earlier, it's like about contagion. Like, we have seen Tether's total assets shrink in this latest market volatility, so presumably it had to sell some of its assets. I haven't looked at what's gone on with USDA. I don't know if it's had to actually liquidate or if people are just hang out in USDC. But is there risk of volatility? I mean, you expect obviously the stable coin industry to get much bigger.

Otherwise, you wouldn't be in it. You know, it's day one. Like, is there risk of crypto market volatility forcing liquidations? and other assets and therefore spreading volatility elsewhere into the financial system? Yeah, I certainly think that's one of the things that the regulators are concerned about. And that's, you know, if you go back and look at the president's working group report that I've referenced a couple times already. You know, there are concerns about contagion and, you know, this points of liquidity stress, etc., which is, which is candidly one of the reasons that, that we think, you know, from our perspective, and I'm not, you know, hey, I'm a free markets guy.

Clearly, USC has found product market fit, right? I mean, they didn't, you know, they weren't sitting in their garage trying to come up with something they hoped that the industry would use. They launched something and the industry, you know, has said yes, and they're speaking with their wallets and there's over $50 billion of, you know, backing USDC right now. What we see is that there is a need for a tokenized dollar to be used by consumers to pay for things. And, you know, the way, and I know I'm getting off your question, Joe, but this is important for, you know, for me to say because the way I think about this is not dissimilar to the way I've described how we don't, you know, we don't encourage our customers to keep a lot of excess deposits with us. I think about a tokenized dollar, the way I think about a physical dollar bill, or let's say a 20, because you know, you typically can only get 20s out of the ATM, right?

So if I go to the ATM and I pull $20 out, well, now that's no longer in my bank. It's not FDIC insured. I can take it anywhere and I can use it to pay for something. But importantly, I didn't withdraw all my money out of the bank. I only withdrew what I needed to transact. So I think that that is the place for a Silvergate issued tokenized dollar. And we've also started talking about it internally, and we're beginning to talk with our regulators about this as well.

We're getting away from calling her stable coin because obviously stable coins have a really bad name because they've proven themselves to not be stable in many cases. But for us, we're looking at this as, hey, this is, hey, this is a. a tokenized dollar. Right now on my iPhone, I have both the Dunkin' Donuts app and the Starbucks app. And I can load both of those with value, but guess what? It's not interoperable. I can't pull it back off. And I can't take my Dunkin' Donuts app and pay for a coffee at Starbucks. And so what we see, and this is a longer view, and it's going to take a while to get there, but everything in the world is moving digital. And people say,

well, money is digital too, and that's true for all of us in the first world. But there are many people that don't have access. They all have phones, but they don't have the ability to pay for things. And so I just view a tokenized dollar as a way to take some portion of your value that whether you have it sitting in a bank account or whether you have it sitting in Bitcoin, pull that out, put it in a digital wallet on your phone so that you can use it to pay for things, whether that be an online merchant, whether that be at a physical merchant. And so that's that. And to me, that shouldn't create any concern about financial contagion and runs on the bank and all of that stuff because it's no, it's no different than withdrawing cash out of an ATM.

So Tether, okay, clearly controversial in many ways. There have been questions swirling around what exactly is backing it for many, many years now. You have a vantage point. where you see the flows and the mechanics of what happens when stable coins are moving or not moving. So you described, for instance, when we had the big run recently, there was an increase in your deposits and lots of money flowing in. Can you give us your take on Tether and what exactly is going on there? Because I think a lot of people are still concerned about a lack of transparency on the backing. and a lot of people have also been looking at the deposit data for Tether, and I think their bank is, it's in the Bahamas, right?

Like DELTEC or something. And basically saying that we don't see deposits moving in the way that you might expect when Tether is actually moving. And again, this is something that's supposed to have billions and billions of dollars worth of assets backing it. So could you maybe just give us your opinion of what is going on there? So unfortunately, my knowledge is limited, just as the rest of the world's knowledge is limited, because we don't bank them, as I mentioned.

But what I can tell you is that our customers who use Tether, and we have customers all over the world. We have customers in Europe and Asia and Latin America. And those customers that use Tether do not have. the same concern that I hear that you just, you know, articulated. And so there's a, there's clearly a difference in perception between those who are inside the ecosystem and those who are outside of it. Now, I don't know why that is, Tracy, I, but I do know that when we talk to our customers, because we've asked them, you know, what if we were to issue our own? This goes back,

obviously, like 2018, 19. What if we were to issue our own, you know, how do you view tether and they use tether because it works. And so unless and until there is a run that actually causes them to burn through all their cash and then their securities and then, you know, theoretically their commercial paper and, you know, it's, it just works. And there are, by the way, also use cases that I've heard of where people in other countries who want to hold U.S. dollars because they might be in a country that that is experiencing hyperinflation, they're comfortable, and these are like consumer folks, they are comfortable holding tether as a dollar proxy.

And, you know, I don't know how widespread that is, but I've certainly heard that. Ellen, thank you so much for coming on. This is just like such a big area. And we know there's like tons of money going into this space and it's so crucial. And so really appreciate getting your perspective. I feel like we could probably do like three hours, actually. on this topic. We'll have to have you back because I think like stable coin design, stable coin regulation, the business of stable coins is not going away anytime soon.

So I appreciate you coming on odd lots. Yeah, I really appreciate the opportunity. I'm happy to come back anytime. I absolutely love this space and appreciate all the work that you guys are doing. Absolutely. Have it great. Thank you. Take care, Ellen. You know what was interesting was that Ellen said, that they might think about rebranding stable coins. It is seemed like it's kind of gotten tarnished,

because on the one hand, you have TerraUSD, which is not stable. And then on the other hand, the other stable coin is tether, and people are just sort of suspicious of it for obvious reasons. So it's like if you're going to launch something, maybe that's smart. Like call it a tokenized dollar or something else, because I do think it's sort of a dirty word at this point. I agree. But you know what this whole thing reminds me of?

And this is a slight tangent, but like it is actually really a parallel to what's going on here. Do you remember peer-to-peer lending? Yes, yeah, absolutely. Okay. So peer-to-peer lending, this whole idea that individuals could lend to other individuals and thereby bypass the banks completely. And the irony was always that there was actually a bank underwriting all these loans. It was called Web Bank. So this kind of, you know, reminds me.

So that's point one. And then secondly, they also rebranded from peer-to-peer lending to direct lending once it became very, very apparent that the lending was not, in fact, peer-to-peer. So it kind of reminds me a lot of that space. That's a really good analogy. You know, speaking on the tether point, and this came up, you know, I think like going back to the first time we ever interviewed Sam Bankman-Fried, it really is striking the degree. of confidence that people in the industry have with Tether and their comfort that they have redeeming and minting and burning Tether versus the outside skepticism. It's like this huge bid-esque spread, so to speak, on Tether as a concept. I mean, it would be pretty amazing if

all of Tether's problems just boiled down to like a perception gap and a bad PR strategy between people who understand it and people who are outside of the space. Like, that would be pretty insane and also a massive own goal for the company itself. But that's kind of what we hear consistently. It's like, well, the people who deal with it have full faith in it and people who are not dealing in it are extremely skeptical. Yes, but on the other hand, note that Allen is not a tether business partner. So it is striking that. I mean, again, there are reasons for that. They're offshore, et cetera. But here is the company that sort of like is the core banking infrastructure. to all of crypto and Tether isn't one of them. So, you know, there's something going out there.

And not necessarily bad, per se, but there's a reason, you know, Silvergate is not a Tether business. Yeah. But I do think getting back to that rebranding point, I mean, we started out this conversation by saying that the marketing here matters. And if you say you've created a stable coin and it's one for one with a dollar and then it isn't, then that's an issue. And that's something that regulators, you know, will pursue and will be interested in. But if you morph into something like a tokenized dollar or, I don't know, call yourself like a variable stable coin or something like that, I don't know, then maybe that does lessen some of the pressure. But of course, the question is whether or not you're sort of abdicating your original use purpose.

I also think this question of like, okay, if something is going to be called a stable coin or whatever it is, there's going to need to be more rules, I think, about what actually backs it and how much it has to be backed by short-term treasuries or long-term treasuries or things that absolutely are dollar equivalent versus other assets. Because as they get bigger as an industry, these sort of like stresses are going to emerge. And again, going back to the financial crisis, the lesson is crises happen in essentially assets that are deemed to be stable. Like that is the source of trouble. And so what they can really hold, how liquid they have to be, how fast they have to be able to liquidate their assets to meet redemptions are sort of like huge questions that I think we're going to need to just get like clearer answers on.

Right. So I guess there's two options here. One is you agree these are safe assets. They're supposed to be safe and there's going to have to be some sort of oversight on. them. Or two, you say, actually, maybe they're not that safe and you step away from that marketing and you go in a totally different direction. But then again, the question is what impact does that have on crypto? Yeah. No, it's a fascinating. We really could probably talk for like three hours and go down all kinds of little avenues on this because it really is like pretty big

to think about the future of crypto. The stable coin rabbit hole. It's also, I mean, it's also just interesting from the perspective of what is money and what is the financial asset and what makes something safe and the contagion effect. Anyway, yes, you're right. Okay, we should stop. Shall we leave it there? Let's leave it there. All right. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway.

And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. Follow our producer, Carmen Rodriguez, at Carmen Armin. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening. Thank you.