The Breakdown - A Real-Time History of the Crypto Banking Crisis, With Austin Campbell

Episode Date: March 18, 2023

NLW is joined by Austin Campbell, Adjunct Professor at Columbia University and former banker and stablecoin operator, to discuss the recent crypto banking crisis. They discuss: Why interest rate risk, not crypto troubles, was the source of the problems Why even banal regulatory disinterest in crypto could create significant problems for the industry  What rules need to change for crypto to fit in a U.S. banking framework   

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDest. What's going on, guys? It is Saturday, March 18th, and today we are doing a real-time history of the crypto banking crisis. Before we get into that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, guys, I'm super excited for today's show. My guest is Austin Campbell, and as you will learn, he has a very diverse set of experiences

that make him a really great conversation today. He has been deep within the plumbing of the traditional financial system. He's worked at banks. He was recently at Paxo, so has that stable coin experience. And in this conversation, we go deep on what has been happening, with the crypto banking system specifically, but also the U.S. banking system more broadly. We discussed to what extent crypto was or wasn't the issue at banks like Silvergate. We talk about interest rate risk and how it's led to unrealized losses on balance sheets with banks serving all industries.

And we talk a lot about why even if there aren't mustache-twisting Dr. Evil villains, trying to kill crypto from on high in their positions of power in the U.S. government, underlying biases about crypto can translate down into policy that ends up having the same chilling effect. I know you're going to enjoy this conversation, so without any further ado, let's dive in. Austin, welcome to the breakdown. How you doing, man? I'm doing quite well, all things considered, which is quite a statement after the week we just had.

It has been a fascinating time. You know, you and I were just talking. I was thinking about how to frame this conversation and knock on wood, whatever would I have around. we're in this interesting sort of, I don't think that we quite know yet whether it's a nice breather or the eye of the storm where there's a little bit of a pause, but it seems like the worst of what might have happened at the beginning of this week has not come to pass. Now, there's still big questions around the underlying banking system right now, not just

in the context of crypto, but more broadly. And I thought what might be valuable is using that breather, however short or long it might end up being, to kind of ground ourselves, especially folks who maybe are starting to think about some of these structural issues of the banking system and crypto's relationship to them for the first time, to ground ourselves in a little bit better a basis. Before we get into that, it would be great to have just a little bit of your background. You kind of have a particularly diverse set of experiences that lead you to this conversation. I'd love to share that a little bit more with some of the listeners. Yeah, absolutely. So there's kind of a running joke.

among some of my friends that if somebody had taken all of the silly things I've done in my career and put them together into one thing, it'd be a stable coin, which is a lot of how I've ended up here. But why is that the case? So in terms of my background, I started back in the day in sort of exotic financial products and made my way through that to J.P. Morgan. And immediately post-crisis, I was part of the effort to put back together something called stable value, which is a product that exists in the retirement market where you have a diversified portfolio of underlying things, and you're supposed to be able to transact in and out of it at a fixed price. Well, that sounds a lot like something that we might get to later in this conversation. So I was at JP looking at stable

value, something called bank-owned life insurance, which is what got me into looking at bank ballot sheets and some other related products. From there, I sort of found my way almost accidentally into crypto. I worked at Stone Ridge, which is Nydig's parents, so then I started looking at what was going on in NIDIG and helping with a few small things there and moved on to city where I was in rates trading and the co-head of the digital assets team within that business unit at city. And then most recently was at Paxos head of portfolio management actually running the stable coins there. So I've been sort of standing at the intersection of call it complicated financial problems and a lot of technological innovation for a while as a result of that background.

Amazing. You are then sort of at the epicenter of a lot of these converging trends. Let's start with Silvergate, as this is sort of the piece of this puzzle that started at all. What was your perception of Silvergate, you know, kind of pre this last crisis phase? You know, November, December, after sort of FTCS had collapsed, and maybe to whatever extent it's valuable, you know, how they were looking even before that. Because I think obviously this is sort of an important piece of this puzzle. Yeah. So I think an important thing to understand about Silvergate is that in the macro scheme, they were a very small bank.

Right, like when you think of bank balance sheets and you hear something like, oh, Silvergate had in the tens of billions of dollars of deposits, if you don't stop to think about scale, that could sound pretty big. But it's like a benchmarking exercise, J.P. Morgan's balance sheet is well over $3 trillion. So Silvergate is a small bank. And the primary value proposition of Silvergate was that they had an internal payments network called SEM, which allowed you to transact 24-7. So when you looked at Silvergate from the outside as somebody in the crypto-eco-eco system, their primary use was, let me just put deposits there. I have counterparties who are also putting deposits there. And what that means is outside of regular U.S. banking hours, because crypto is, of course, 24-7, I can then transact with finality in real-time on fiat rails, so that, for instance, if you're minting or burning a stable coin, or if you're trading crypto and you're trading it against dollars, you can align the times of all of your systems. And so from that perspective, of Silvergate, to be honest, was a pretty simple and non-complicated bank, right? Like, as you look at them, they weren't in some of the hairiest businesses in the banking world. Like, they're not in, like,

large-scale derivatives trading. They're not deep into the weeds of investment banking, which everybody knows is highly volatile revenue. You know, in some ways from the outside, it was a pretty simple bank in terms of the concept of what they were doing. How does the Silvergate-Send network compared to Signatures, Cigit Network? Was it effectively the same thing? Were there key differences? So from a customer perspective, I would tell you they were essentially the same thing. I think there is one key difference between the two implementations, which ironically

becomes more of a business terms thing, which is that SEN historically was something that Silver Date would potentially even charge people to use, and they didn't pay interest on deposits at all. Compare that to signature, where they paid you at least some interest on deposits and weren't charging a ton for Cigna. And what that meant is that Silvergate had a reputation in the market of being pretty sharp elbowed about economic terms, unlike signature. And I think to some extent, when you come under pressure and people have been rubbed the wrong way by you, it's much easier to pull deposits and run away than it is by somebody perceived as a long-term ally. So if you're looking at

some of the speed and ferocity of people pulling deposits out of, you know, said, that is something that may have been a contributing factor. Yeah, super interesting. So this big pull out of Silvergate really starts in earnest in December especially. I think at the beginning of Q4, they had something like 12 billion in deposits, which was down from their all-time high of 16, I think, and 8 billion float out in December. How much were you paying attention at that time? How beleaguered did they seem from the outside? Yeah. So when you're looking at it from the outside, it's always hard to see exactly what's on a bank balance sheet. They have a little bit of a black box phenomenon on going on because you have a loan book and a securities book that serve as the assets for a bank.

And I know that sounds backwards to most people, but it's important to remember that for a bank, deposits are their liabilities because the people who gave them those deposits can come and ask for them back at any time. And their assets are the loans and securities because they're lending money to people with an expectation of not just being repaid, but earning some interest on it. So this is their profit engine. So when you're looking from the outside, you're asking two things. One is, do I think all the other depositors are going to leave. And in the case of Silvergate, that trend exactly, as you had said, had started before even this sort of period of crisis over the past few weeks. The second is you look at their assets and say, okay, if everybody leaves, do I think they have

enough money if they have to liquidate all of this stuff to pay everybody back or any uninsured deposits at one of these institutions at risk? So I can say, I think generally the crypto community had made the judgment that they thought Silvergate was going to experience some loss of deposits and people were pulling away from them pretty significantly even in December. I know people would reduce their exposure by 50 to 100 percent there. A lot of this gets sort of murky pretty quickly. How much do you think that had to do with the general retreat from the industry, which was happening at the same time, versus was a specific indictment or concern around Silvergate? You know, obviously you started to see very quickly at the beginning of December political pressure on Silvergate as relates to their relationship with FTCS and Alameda, but it's not necessarily super clear to what extent those December sort of deposit withdrawals had to do with that versus just, again, sort of a general move away from the industry.

So I would say keep in mind a lot of the people who had deposits there are crypto companies, meaning that they're going somewhere else, right? So, for instance, if I'm Coinbase and I had been banking at Silvergate, I'm not saying, well, I'm done with crypto, shut it down, give the money back to investors. They're just getting a bank account somewhere else. Most of the money from Silvergate, I think personally, was probably just moving to other places within the ecosystem. I mean, we certainly observed that at Paxos. Like as, you know, call it transactions on send, we're going down, transactions on CigNet were going up, which implies that people are moving just from one bank to another bank. Because if it's your core business, you kind of can't take the money out without shutting your business down. And a lot of Silvergate's core business was crypto. So it's more, you know, call it reallocation due to risk than complete flight from the industry. I think when you see complete flight from the industry, that's more likely to be investors pulling back on investments, people selling their crypto and getting into cash. Maybe some of the stable coins declining in size. But as a stable coin, you still need liquidity.

So as I decline in size, that's more the securities portfolio. folio shrinking rather than just a cash buffer. So December happens. This is going on. Money's moving around. Money's moving out of Silvergate, perhaps into Signature. But at the same time, there's clearly this ratcheting up of political pressure. I think didn't Signature announce in December that they were changing the way that they were

going to settle crypto transactions and they imposed a $100,000 limit or something like that? Yeah. So the $100,000, it was a minimum, which was basically intended to not make sense. SNET available and not serve as a third-party processor for retail transactions. Right? They were kind of moving CigNet to be called it institutional only, right? Or maybe high net worth individuals. And I can say with certainty, there was definitely a degree of regulatory pressure around that. There's always been sort of persistent and ongoing questions from the U.S. banking regulators about public blockchains in general. And you could see that

skepticism come out later in January when there was a policy system. statement from the federal banking regulators, where they specifically said they don't see as permissible activities banks acting as principal with, you know, crypto tokens of any sort. And with regard to things like stablecoins, they don't think that tokens on public blockchains were, shall we say, like conforming with safety and soundest principles for banking. And so that's a pretty big shot across the bow and could demonstrate they're going to have a lot of skepticism about even the cash banking components of those sort of efforts. So we have this ratcheting up of political pressure. We have moves within the space, both out of the space, but also probably more lateral in terms of moving around banking exposure. Maybe introduce the FHLB loan for Silvergate, as this would become an extremely contentious part of the story and I think has a lot of murkiness around it.

Yeah, so to deeply simplify this, the FHLB can loan money to banks. And one of the problems that you have as a bank, back to what I had mentioned earlier, is when deposits are leaving, and you have all of these securities on the other side of your balance sheet, you may not want to sell them necessarily, especially not if you're in the case where after you've bought these securities, interest rates have gone up, therefore the securities have fallen in value. Therefore, if you have to sell them, you're losing money. And so one of the ways that banks can stay alive in those situations, especially if the deposit

flight is temporary, is essentially various forms of borrowing and short-term funding. The FHLB is one of those. The Fed has various facilities. Sometimes you can borrow in the repo market against other banks. But point is they were using that as a source of liquidity so that they could pay out all the depositors leaving without further impairing their balance sheet. When you were looking at this, did it strike you as weird that they were getting a federal home loan bank loan, even though they were primarily a crypto bank? Yeah, I would say in general, it's not a great sign for banks period, full stop, when you have to engage in emergency borrowing to fund deposit outflows, right?

I think that is something that is not specific to crypto. If you go back and look at sort of 2008, that was one of the concerns is who's extremely levered, who's engaging in a bunch of short-term borrowing just to stay alive in terms of who was looking at, you know, bankstress. And so I would say you can leave the crypto part out of it, having to tap liquidity facilities in that way is usually at least a yellow flag, if not a red flag. Do you have a sense now? Resuming ahead a few months, because this remains a major point of debate. In your estimation of what you've seen so far public statements, it seemed like that FHLB loan was called in extremely quickly. I think the most recent statements that came out said,

we don't know why Silvergate decided to pay it back. What have you kind of seen around that? And does it strike you as out of the norm? Or is that sort of the crypto industry making hay out of nothing? It's hard to say from the outside. That goes back to Bagspeed black boxes. There could be strings attached to those loans. And so one of them could just be that the economic terms of a loan changes and it's just not functional anymore. Right. So if Silvergate's got, for instance, a bond portfolio that's earning them 1.5% because they bought it when rates were lower, and that loan goes up to like a 5% loan. Well, now you're deeply underwater if you take that anyways. So unless it's very short term, you're going to pay it back and potentially unwind

operations, which is what Silvergate is doing. Another potential option is that, you know, one of the terms you typically have in things like that is that you've got to be adequately capitalized. So if the regulators felt they were not, now you have another potential source of problem. And one of the things I would urge people not to call it overfocus on in the crypto community is like very legalistic terms and conditions when you're dealing with banking regulators because they don't work like the securities regulators necessarily, right? Where there's laws and you have to follow the laws and there's interpretive letters and you have to strictly follow those. Bank regulators have a lot more of what are called prudential powers. Like they can

look at you and make a judgment of do we think you're managing your risk well? Do we think you have adequate capital? Do we think your policies and procedures are sufficient? And some of those are judgment calls. They're not just numbers. And so the whole regime is a little. little bit different as you try to evaluate things like that. Yeah. In short, hard to tell, right? So it's not clearly some smoking gun that says there was intense political pressure being put on the FHLB or anything like that. It's hard to know by the very nature of what sort of powers bank and bank regulators have. Yeah, that's one part. And the other part is looking at it from the outside as somebody who's, as I said, looked a bit at bank balance sheets. It's pretty clear that Silvergate had made a decently

big mistake with regard to how they were managing their balance sheet. So I think there's at least a plausible argument from the regulatory perspective that, oh, no, this thing's in real trouble and it's probably going to die. And that mistake was that when you're a bank and you take deposits, you're always thinking about your asset liability matching, right? Like you have models of your deposit stickiness. And how sticky you think those are determine how far out you can go when you lend, right? So if I'm a bank and I know with certainty, none of my depositors are ever going to leave for any reason, I can kind of lend infinitely long and it's okay. But obviously, that's an extreme. And you're always coming down that curve and trying to figure out three years, two years,

what proportions, how quick. And the reality is crypto deposits can move around pretty quickly. This doesn't make them unbankable. But what it does mean is that when you match assets against them, those should be pretty short duration assets. So if I go and buy like long duration mortgages and then people withdraw, I can have a real problem if rates went up. And that's what it appears that Silvergate did from the outside. Whereas if they had said bought nothing but T-bills, they probably would have been five.

So this is an interesting piece and kind of where I want to shift the conversation next, which is in many ways the cryptoness of the whole thing was distracting people from the bigger underlying issue. and not just crypto people, but the entire market, when they were looking at Silvergate, by and large, was looking at it in terms of just its crypto issues and crypto prices crashing and this sort of thing, rather than as Exhibit A in this much larger phenomenon. So let's talk a little bit about that larger phenomenon. The duration mismatch, as well as sort of interest rate risk. Let's talk about it sort of on a core level again, just to refine it. And then let's talk about

to what extent during the zero interest rate policy period, banks based on their, you know, not just Silvergate, but banks in general almost had to move farther out in duration because it was the only way to get yield. So let's kind of move from the crypto side of the equation to just the more fundamental sort of banks over the last three to four years conversation. Yeah. So if you think of the model of a bank, there's this old joke that banks follow the 363 model, which is, you know, borrow your deposits at 3%, lend them out at 6% beyond the golf course by 3. And so what that ultimately means is it's getting to the concept of net interest margin, which is to say, I have to pay something on my deposits, but then I'm making loans. The difference

between those two is my earnings as a bank. So when you have a zero interest rate environment where I can have deposits, pay zero on them, but then go buy, say, T bills and also earn zero on those, you don't have a business model, right? That doesn't earn you anything. And so for banks to make money, they either have to take credit risk or they have to extend out on the duration curve, which means lend for longer periods of time. And to be clear, from the perspective of like the Federal Reserve, this is working as intended. The reason they were keeping interest rates low is to try to force people to take more risk and engage in economic activity that ideally would help things grow. The problem this creates as a bank is if you misunderstand in that period the stickiness of your deposit,

and you're lending on long-duration things to earn that net interest margin when rates go up, especially when rates go up quickly, you can end up upside down very fast, right? Where now, potentially to retain your deposits, you have to pay a higher rate of interest than you're making on the loans. And so to that extent, I would tell you, the current situation we're seeing where that sort of pressure is probably more present in simpler banks, smaller and regional banks call it, is somewhat related to what happened with the savings and loan crisis in the 1980s more than 2008. 2008 was a crisis of, you know, potentially the biggest of banks, a little bit more systemic.

Here, the problem is, as you look in the market, you have a lot of banks and not just crypto banks, because people like, say, First Republic, you know, and Pat West have come under pressure here too, where just the problem is their net interest margin has gotten compressed, and then that makes you question their forward profitability and sort of balance sheet. this is a huge part of the story underlying Silvergate, obviously, even if it wasn't the part of the story that we were paying attention to. But this is sort of what rears its ugly head and slams itself into consciousness at the beginning of last week when Silicon Valley Bank announces that they've had to sell something like $22 billion to cover withdrawals. And they took a $1.8 billion loss on that and they were raising $2.25 billion more. And the market is like, whoa, whoa, wait, wait, what? And so let's get into that a little bit. your perception of what was happening with Silicon Valley Bank and how the kind of the market started to grok that. So I would tell you the story at SVB was basically exactly the story at Silver Date, and that's what kind of demonstrates this is not a crypto problem, right? Because what happens

at SVB? SVB is a bank that has been around for quite a while, was very constructive with the tech community, very well regarded out in the San Francisco area. They banked a lot of fintechs, regular way tech companies, banking as a service type implementation. and by the way, they banked some crypto companies, but I would tell you that was not a majority or super majority of their exposure. It's actually more of a footnote if you look at who had money with them. Circle might be the one outlier there where they were just leaving large cash reserves there, but Circle didn't withdraw them importantly, or at least not until the last minute. Now, what happened with SVB was essentially the same problem as Silvergate, which is to say they had

gone and bought long-duration bonds, interest rates go up significantly when the federal Reserve raises them. And when depositors start withdrawing money, especially because if you look at tech in general, that space hasn't done well. You'd expect cash burn to go up. People are spending down to stay alive. That will naturally reduce deposits, even if nobody's actively fleeing from SVB just because they have less cash. And so SVB ends up in the position of being like, oh no, we need additional liquidity. Our balance sheet isn't in great shape, so we don't want to sell all these long-dated securities, let's go raise money. The problem that creates when you're a bank is it also tips people off to the fact that your balance sheet is not in great shape. That in and of itself can cause the

panic. And once people start withdrawing for that reason, you very quickly sort of slide down the hill and end up out of business, sometimes in a matter of days, exactly as happened as Phoebe. How much did it matter, I guess, from a narrative construction standpoint, that Silvergate announced that it was winding down the same day that Greg Becker, the CEO of Silicon Valley Bank, is trying to calm investors by telling them to stay calm, not to panic, and that people would only be freaked out if everyone else got freaked out. So I don't think Silvergate had anything to do with why SVB sort of unwound so quickly. SVB's problem is a math problem, right? You cannot fight basic arithmetic. And when you have a tightly knit, highly communicative community,

and the bank that banks all of those people tells them, hey, we may not have enough money, whether Silvergate had happened or not, people are aware, at least in a rudimentary way, of how banks work. And the problem with the deposit flight issue is if there are uninsured deposits and your bank may not have sufficient money to pay everybody out, it's a prisoner's dilemma, right? You should go first to get your money out because if you don't and everybody else does, you're left holding the bag. So everybody rushes to the door to get their money out. I would tell you, I think that's pretty well supported by looking at the experience of people like, say, FRC. So First Republic is not a big crypto bank. They were still having a version of that

problem as well, even though they had been saying, hey, we're in a stronger position, we're better capitalized, we think we can make it. People still started taking large amounts of deposits out there. How much do you think Silicon Valley Bank demonstrated just a new phenomenon that we're going to have to contend with in general, which is the speed with which information flows and the fact that pulling money from a bank happens with rapid quickness based on mobile and phones? So I think what you've hit on there is one of the greatest insights of this period, which is we've gone from a world in the 1980s where to get money out of your bank, you've got to like put clothes on, you know, go to your driveway, get in a car, drive to the bank, fill out a bunch of paperwork,

then get money out of the bank. So a bank run kind of moved at analog speed, call it, right? You've got to actually do some things in the real world to go get your money out. Now, you hop on your phone and five minutes later, you're sending a transfer from your online banking app. Right? As the speed of information transmission has increased, the speed of people reacting to information can also increase. I do think we live in a world where if I were a bank treasurer, I would be having a very deep think right now about my deposit models and thinking about social media risk and sort of information transmission speed and maybe reevaluating my previous views on sort of stickiness and duration of deposits. And again, I don't think that has anything to do with crypto. I think that has to do with just sort of the internet and communication in the modern world.

Like Twitter is not reliant upon crypto, but it sure played a part in what happened with SVB. Join CoinDesk's Consensus 2023, the most important conversation in crypto and Web3, happening April 26th through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, entrepreneurs, and more. Use code Breakdown to get 15% off your pass.

Visit Consensus.com. Desk.com or check the link in the show notes. It was fascinating to watch that Thursday, how almost naive, if well-intentioned, it felt to watch the sort of Mark Sosters of the world, try to rally the venture capital community and say, don't tell your people to withdraw money, you know, from these banks, because it becomes a self-fulfilling prophecy where all of these startups, it's crazy to even consider that risk. It's like the prisoner's dilemma wasn't even a dilemma.

There was no other option. It was so clear that there wasn't an option. I wonder how much that had to do with the feeling of the hyper-compression of the decision-making cycle because of social media as well. I think that's part of it. I think the other part of it is just, to be honest, the economic realities of the decision you make, which is to say, if I choose to leave my money in the bank, I can potentially lose a lot of money if they go down. And if they don't go down, I still have the same amount of money I had at the start. right? There's no upside to leaving your money in a bank when there's a deposit run. You're not like

an equity holder where you're going to get returns on the back end. You're just going to keep the money you already had. So it makes it very trivial to make the decision to play defense to take your money out. Exactly as you said, if you're a fiduciary at a company and there's a bank run going on at one of your banks, you take your money out. Right. It's a pretty trivial decision. And that's why bank runs are so dangerous and why the regulators were rightly concerned about contagion spreading in that fashion. But I agree with you there. I think when this is going around on social media, given the economics of that decision, everybody else looks at that decision and everybody's going to run at the same time. So this gets us to the weekend. There's a lot of chaos or chaotic

kind of screaming about bailouts or not. I want to come to sort of the decision that was made and announced on Sunday in just a moment. But, you know, I'm sure you were glued to your screen as we all were over the weekend in terms of the debates around, you know, bailouts or what that word even means. Was there anything that surprised you about the discourse on, call it Saturday, as the Silicon Valley set was trying to figure out what was going on and people were weighing in, sort of very subjectively, I'm interested in kind of what your experience of that was. Yeah, so post-2008, where we had this whole debate about bailouts, you know, there was at least for a moment there, a pretty deep national discussion about what it means in these moments.

to bail people out and how these things should be handled. So one of the things that most surprised me going into the weekend was, I would say, how misunderstood the discourse about bailouts was. Because if you think of the capital stack of a bank, you really have three kinds of people in there. I'm oversimplifying, but let's call it three for the purposes of this discussion. You have the depositors, you have senior debt holders, bond holders, people of that sort. And then you have the equity holders. So to be clear, the owners of the bank, the people who make a profit off the operations of the bank are really the equity holders. So, for instance, when I was at J.P. Morgan, when you get paid, at the end of the year, I would have my salary,

I would get some kind of cash bonus, and then I would get equity as part of that, right? It's supposed to tie you to the long-term incentives of the bank and help, you know, sort of incentivize you to make money. And so one of the things that happened in 08 was when banks were bailed out, they got capital injections that helped, you know, sort of bondholders and equity holders. Here, what people were talking about was purely making the depositors whole. And I will tell you, with certainty, most depositors are not engaging in sophisticated credit analysis before they put their money into a bank, right? If you're a local grocery store chain, if you're a winery in Napa Valley, if you're

a nonprofit and you banked with SVB, and by the way, I think all three of those kinds of businesses did bank with them. Nobody's going and looking at the balance sheet and trying to make a big profit. They're just saying, who's my local bank and are they easy to work with? so can I leave my money there and will it be safe? So to my view, a bailout as we think about it, where you're enriching bankers or tech people or investors, is really one where you're trying to save the value of the equity holders and to a lesser extent the bond holders, when you're wiping those people out, like all of the people associated with that are going to zero, but you save

the deposit holders, I view that as a different sort of bailout. To make it simpler for people, it's a little bit like saying if Amazon goes bankrupt and you, you were a retailer who sold inventory through Amazon, should you lose all your inventory because Amazon went bankrupt? That is kind of the equivalent of bailing out the depositors only. And I think that was really misunderstood and it was interesting to me because that leads to a lot of people pushing back against certain forms of intervention that if you let a bank fail in disorderly fashion and don't protect depositors, the message you're sending to everybody is if your bank is not either systemically important or you've got money above the 250K threshold, which is a lot

of corporations, right? It's easier for individuals to be below that. But if you're like a chain and you do a lot of sales, it's much harder. Take your money out of a bank. And that is dangerous. So let's talk about what was announced on Sunday and sort of, you know, what the reactions were to it. So Sunday, well, I was going to say there were a couple of things. One of the important ones was that it looked like the government solution was coming together such that SVB would not be rescued as an ongoing institution. Like they did not bail out the equity holders, you know, people who own certain forms of debt, they're all going to zero.

But what they were going to do is make sure that none of the uninsured depositors lost money. So the phrase you're hearing is 100% or unlimited deposit insurance for SVB. That means if you were just a business that happened to have money there, you're not going to take a haircut. The other thing that happened on Sunday night that was interesting, and this was kind of curveball for a lot of people, myself included, to be totally honest, was that they also announced Signature Bank was being shut down. So it wasn't just SVB. Another bank was joining

the ranks of those who were being turned off as a result of this. So Signature we talked about a little bit before is another sort of major bank servicing crypto, but is not the same dynamics as Silvergate, where Silvergate at an even time had 80 or 90% in crypto deposits, whereas I think signatures max was something like 25%. That sounds right. At the time they were, went down, it was less than 25%. As you had alluded to, they'd been downsizing that business for a while before we even got to this point. So signature is announced as part of this that their depositors would be protected because, oh, by the way, the New York Department of Financial Services had made decision to shut them down as well. You know, obviously it's been an absolute swirl of

accusations and recriminations from the crypto industry, but also from signature board members, like Barney Frank. What was your perception when it was first announced? What was missing from that announcement. Have we gotten any more clarity since then? And what do you think kind of the state of common knowledge is, I guess, now about why signature was singled out to be shut down? All right. So to take the last question first, the answer is confused. There are still many conflicting narratives on signature. So I'll tell you what I'm observing as I look at that situation. So number one, there was definitely some degree of deposit outflight from signature. I don't think it was as severe as SVB. It was probably more on par with what you were seeing at first repulatory.

public pack west, other places that were seeing deposit outflow. Number two is that signature had done better on net interest margin than either Silvergate or SVB had, meaning that their asset book, they're probably still underwater on significant parts of it because that's what happens when rates go up. But they were paying more competitive market rates to depositors than some of the other banks without completely destroying their net interest margin. So when Barney Frank is out saying, I think we could have continued as an ongoing concern, And what that means specifically is he's saying, we're generating a lot of income from the loan

book. We think we have adequate liquidity to fund the deposits that want to leave. And we don't think there's an avalanche of future deposits following those. So the reality is his view is probably more, hey, you know, we're beaten up and bloodied a little, but we're not down for the count. We can keep fighting and we're probably going to make it. So that would be call it what you're hearing from some of the senior folks at signature, you know, one board member included. If you look at what the NYDFS has said, they've kind of,

you know, evolved their story over time, shall we say, but said two different things. One is that they thought the bank was in danger of going down, as in the run was bad, and there might be something there in terms of them just not being a going concern on Monday. And then they sort of pivoted that story after, you know, other people started accusing them of having animus for other reasons, to say there was also a crisis of confidence in the bank's management. And from what I understand, signature had been working all weekend with the assumption that they were going to operate on Monday and they did have adequate liquidity. And the decision late Sunday to shut them down seems to have come as something of a surprise. So when you're reading between all those lines, what that leaves you to ask is why, specifically would the NYDFS have a crisis of confidence in signature?

because I would tell you objectively as an outsider, I think shutting down signature is probably about a jump ball when you look at Sunday night in the position everybody was in, but that I didn't see anything materially different about them than some of the other banks that it had significant equity declines the day before and maybe deposit outflows. So what was surprising to me, and I think this is where the crypto community has started piling on

and I'll talk about that next, was it was just signature. I would have thought if they were going to be thrown in the stack of like, okay, these guys are going down. I would have expected to see three or four other names in there as well in similar positions, but it was actually just signature. That leads you to the question of, well, what's different about signature from all of these other names? And the answer is that they have a significant crypto banking franchise. So as an outsider, when you know with certainty that there had been regulatory sparring around

Cignette for many months prior to this, when there had been repeated questioning of signatures management for getting into crypto and all, then continuing to bank crypto, then about the safety of banking crypto. It does feel, even if there was a crisis of confidence in the leadership of the bank, that part of the component of that lack of confidence was their decision to bank crypto companies, because that is the differentiating factor from other banks that were not shut down, at least as I observe it from the outside. How much does sort of Reuters reporting last night We're recording on Thursday. This probably comes out on Saturday. So on Wednesday night, Reuters reporting that as they are looking for suitors for SVB and

signature, one of the preconditions for a sale of signature bank is to basically disavow the crypto part of the business. Yeah. So I would say in fairness, I think the FDIC has pushed back a little on that subsequently in the day, but I'm also not sure how true that pushback is. The reality is, you to engage in any banking activity is an FDIC insured bank or, you know, with whoever your regulator is, you need permission to do it. And their permission is conditional upon them having confidence that you know how to operate this thing well and within the guidelines of safe and sound banking. So back to what I referenced about the policy statement they released in January. If their honest view is that there's no way to do safe and sound banking activities facing

companies that touch a public blockchain, then you're going to have to shut down six. So the discussion point of, oh, maybe theoretically there's a way to operate it, but, you know, not with any of the current clients or not with any of the current, you know, like, call it product market fit, does make it a distinction without a difference. And if it turns out to be the case that they're going to require CigNet to be shut down as part of a purchase or just kind of theoretically maybe would think about approving it, but actually disapprove it for whoever the buyer is, that seems to be a strong indication that was part of the problem. So it's super interesting as we actually parse this out because so often the reality of situations is so much more banal and boring than neither of the extremes. But if you have on the one hand explanation as sort of NYDFS has said, nothing to do with crypto, their business was impaired, you know, we didn't like their management. It was about that, not crypto. And on the other end of the spectrum, Exhibit A in Operation choke point 2.0, this is sort of clearly a targeted maneuver. It was close enough on the bubble that it was an easy hit as part of all of this. What you're describing

is a potential middle path where it's almost as though the biases towards crypto that this set of regulators was bringing into it just made them interpret situations differently enough that it pushed it over the bubble without there necessarily being a grand plan, let's say, to target crypto, it's almost that it was sort of in the context of a crisis, it was targeted a priori because of those biases coming in. So to your point, you have NYDFS, which has a crisis of management that's not exclusively crypto, but certainly the way that they had moved into the crypto space contributes to that, right? That helps push them over when it's, you know, if you call it six and one, half dozen of the other in terms of whether they can continue, screw it, push it over

into the side, you know. Maybe there's someone sitting there who's, you know, chuckling to themselves in the corner because they do have machinations against crypto, but it's not necessarily sort of some big grand scheme. Then it moves over into the FDIC's hands. And to your point, the FDIC, the OCC, the Fed have all come out with this guidance that's sort of super skeptical of the ability for banks to interact with crypto in a way that sort of hits this safe and sound manner, which by the way is a phrase that I deplore and I talk about it deploring all the time. And so again, it wasn't the FDIC's decision to shut it down, but now that it's in their hands and they have these concerns about the fundamentals of CigNet, it becomes this thing where they don't want, they're unlikely to approve that going

forward. So it's just something that a buyer has to agree to not do up front. And we're in the same place of crypto being de-platformed from banking, but not from some grand scheme necessarily, even if there are some who might have that sort of ambition to eliminate crypto. But just from the banal sort of analysis of bureaucrats who mostly don't think crypto is a good fit for the banking system and when push comes to shove are going to sort of operate on that basis. So I think all of that is correct. And I think to some extent you've gotten to how a lot of Operation Choke Point 1.0 actually worked, which is to say there's two ways to tell banks they can't do something. Way number one is to just straight up tell the bank they can't do it. Way number two is to

say, no, no, no, of course you can do that kind of thing. It's legal. It's just going to have 50 times the costs for compliance, risk, monitoring, and we're going to be in your office every day, and if you make the slightest fault, we're going to fine your brains out, right? And so what you do is you scare them away from doing it and make the cost of doing it prohibitive without actually telling them no. It's, you know, a little bit similar to being like, well, you know, if you want to build this single family house, you can totally do it, but the permit's $2.5 million, right? And so you just make it un-economic to do it, except it may be the most extreme situations. I think that's much more of the gist of what's going on with the sort of current situation of crypto banking in the United

States. I don't think it's evil mustache twirling of let's shut this down and pave the way for Fed Now. Like Fed Now is a project that's been ongoing for years and years and years and years. Right. And I spoke at the Chicago Fed Payments Symposium. And I think it's a good faith effort to try to modernize the U.S. financial infrastructure, to be clear, because we're pretty stone age. Like Korea, for instance, has had real-time fast payments since the early 2000s. We're way behind here. This is a long time coming. But you can easily end up in a world where just lack of education, excessive skepticism, and a full court push on all institutions that get involved in this space to really tighten the screws on all aspects of controlling that business, just make it on economic

to do it, and therefore you end up debanking an entire industry without specifically just an explicit ban. So this is what's so interesting and I think pernicious about this is you almost have this ladder of conviction where you do have a few very vocal, loud voices at the top. There's no denying that people like Elizabeth Warren and Sherrod Brown want this industry out of America. It's full stop, not a question. Then you have this whole layer underneath, though, of career bureaucrats who probably fit into roughly three categories. One is sort of generally biased against, maybe not the sort of conviction where they're going to go out of their way to fight it, like the Warrens and the Browns, but, you know, are pretty skeptical. And then maybe another layer who don't really feel one way or

another, but by virtue of that are certainly not going to go against the group that's super skeptical. And then probably, unfortunately, a much smaller group who have conviction that it's important for the future, but also have their jobs to consider. So if that's kind of the current U.S. political hierarchy around bank regulators, and then you have banks who are highly opportunistic just by virtue of being sort of market actors, to your point, it doesn't take too much to push down that chain of conviction for it to just become too costly for it to make sense. The cost of taking advantage of the opportunities of banking crypto becomes just not worth it. Well, I would add to that. One, I'm lucky enough to have some personal friends in the regulatory

community. I, by and large, think they're good people who are trying to do the right thing. And I would tell you, I think group three, which is the group who at least have some sympathies towards crypto, is larger than people would expect. But the problem they face is largely an incentives and dynamics one, which is to say one of the issues of being a regulator in the U.S. is that you kind of are in the role of being like the plumber, which is to say when things work properly, nobody thinks about you and you don't get any credit, but when things go wrong,

everybody's screaming at you and you get all of the blame, right? It's a very sort of one-sided outcome for them where when things break, they are constantly in the news and constantly look stupid, but nobody when the economy is booming really goes out and goes, ah, the OCC deserves so much credit for this, right? It just doesn't happen. So you have a natural conservatism towards all activities and it just sort of ratchets over time, right?

You had savings and loan. Then you have long-term capital management in the Asian crisis in the 90s. Then you have the great financial crisis. Now you have, you know, COVID and you've got what's coming out with crypto. All of these are just leading them to be more and more conservative and sort of choking things more and more over time. And so when you're only one way on the decision-making spectrum, you end up at a place like the one we're in right now. And when you step back and look at that from a economic functioning and like core freedom and rights perspective, it can put you in a very negative place, even if some, though not all,

but at least some of these individuals didn't have bad intentions about any individual action. Let's talk about where that leaves us specifically with crypto banking. Obviously, you have the rumblings of political battle around this. You had the blockchain association who earlier today announced that they were requesting a bunch of information through the Freedom of Information Act. You have Representative Emmer who's sending letters to the FDICA chairman asking whether this is actually sort of an intentional concern, specifically using the words choke off, which I think is a pretty clear dog whistle to the rest of the crypto industry. Is any of that actually relevant? Or is that all

just sort of skirmishes that bring this back to Congress to get off its ass and actually decide how crypto is going to be integrated with the traditional system or not? Yeah, I think fundamentally, if you want to change the situation in the United States, you need Congress to take action, right? So let's roll all of this back and remember that all of these agencies only have powers because Congress has passed bills created them and delegated authority to them in part or and whole. Congress has the ability to take all of that back if they want to. They could literally abolish many of these agencies tomorrow by just passing legislation. Now, obviously, in the current U.S. political framework, that's not going to happen.

But I say that because it's important to remember that the ultimate power here is with Congress, again, so long as people are not violating the Constitution, even Congress can't do that in theory. And so we do need congressional action. I think without that, there's not a lot of incentive to change the path. And I think the U.S. is definitely very much at risk of falling behind in technological innovation. And, you know, in many ways, offshoring the future of the financial industry. Because if things are moving to 24-7 live, stable, neutral ground systems where everybody can use them to transact, and we say, no, no, no, we're not going to do that. We're staying out of it. And other people build it, you know, somewhere 10, 20, 30 years down the road, you've lost control of the financial system,

and to some extent the dollar may lose its reserve currency status. And I think we're at that break point where if we can't take action in the next few years, it's going to be a very big problem for the United States down the road. Holding aside any sort of frustration the crypto industry might have with right now, if we were to wipe it all clean, clean slate, get everyone in good faith and together in a room, what are the ways you think that we might want to think about crypto banking specifically differently than other industries, if any? So one is it's attached to a 24-7 system, and as we just saw with SVB, that produces volatility over short periods of time. So I do think there's a reasonable argument that if people are

banking crypto, they should probably be conservative with the liquidity around crypto. Now, doesn't mean you can't bank it. It just means think smartly about, you know, what kind of assets you pair against it. And that may require the regulators to rethink some of the things they did post-crisis, where they basically forced people out of forms of credit risky assets and concentrated them in things like agency mortgages that were perceived as safe because they didn't have a lot of default risk. But ironically, they have a lot of interest rate risk, which is causing problems now. So you've just sort of squeezed a balloon and caused a different part to bulge out. But I think you can fit crypto in, you just need to be realistic about the volatility of some of the deposits. Two,

there should be rules, and this does not just apply to crypto, about fair access to banking for both people in industries. It shouldn't be the case that because somebody is merely politically disfavored or unpopular, that they should be denied services. Right. That becomes a bridge too far. And obviously, from a system design program, like if you don't like crypto, fine. But if you have some future administration that comes in that really dislikes an industry that you're a fan of and they debank that, how are you going to feel that? This is a systemic fairness issue and also one where if banks are in a world where they know that if an administration changes, they're going to hammer them for activity that's politically

unpopular, all politically unpopular industries on each side of the aisle will systematically be debanked over time. And then the last point for crypto banking in particular is I think there should probably be a focus on market structure in general, which crypto itself has also done a very poor job of, right? Like crypto takes exchanges, custodians, and clearing, and kind of gloms those all into a single object, and that's why it's so easy for things like FTX to happen. You don't have the balance of powers where the custodian goes, why are you withdrawing these things to the exchange when they try to take consumer funds and do something funny with them like you would have in a more

traditional financial setup? So I think there needs to be a greater acknowledgement of what the pieces of the infrastructure should be and how to structure them, which then makes it easier to bank them because you understand what the risks are from the outside. Working backwards, because I think each of these is an important point. The third one is kind of counterintuitive, I think, for some crypto folks. It's interesting. It's sort of disintermediation we can look at in two ways. There's disintegration in the sense of literally removing a bunch of intermediaries and having it all in one box, which is what crypto exchanges largely have been. But then there's also sort of a decentralization cost to that,

as we saw with an FTX, where sure, you got fewer intermediaries, which maybe meant more efficiency and lower cost, but you also had less decentralization, more concentration. So I think that's going to be a hard one for the crypto industry to discuss, but it seems like it's kind of inevitable, right? That to some extent, these functions are going to be broken apart as it tries to interact with the traditional system. Now, on the second piece of more trying to figure out what the rules should be around bank services. I think what we've learned from the last administration, going into this administration, is that this is something that has to come again, unfortunately, from Congress, right? Brian Brooks used his nine months in the OCC lead role to make a rule that said exactly that.

And it was quite literally the first thing that was ripped away as soon as the Biden administration, you know, took power. That rule was kind of countermanded. So it clearly just can't come from OCC guidance that all banks need to be, you know, treating legal industries equally. That has to be something that I think comes from legislation. And then I think on the first point regarding just what the sort of right norms are, almost call it, whether it's rules or norms, this came up a lot. You know, when I was reading your piece about Silvergate, I think people wanted to critique them for doing risky things. And the counter was they were doing the same things that everyone else was doing. it wasn't like they were kind of, you know, particularly engaged in buying crazy exotic instruments or

anything. It's more that from a risk management standpoint, I think it's pretty reasonable to say, like, I mean, come on, guys, you understood that you're in a business that is defined by much more volatility. And while, yes, you might not have strictly been required to only hold treasuries or whatever it was, like, you might have thought that that would be a better voluntary decision just on the basis of what happens. And I wonder to what extent that needs to be just sort of written as rules versus is a lesson that whoever kind of returns to this space learns by example. Yeah, and that goes back to some of my commentary on I think the core learning here is actually we need to think about deposit models at banks. Right. Like I would tell you as a former fixed income guy who thought a lot about banks, if I'm laying blame on Silvergate and I'm laying blame on Silicon Valley Bank as to where the failures were, I would be starting with the people who are doing their deposit models and then their treasury management.

To me, this is not an issue with taking those deposits in. It's taking those deposits in and then matching them against assets that were unsuitable for those deposits. You know, same story at both places. And I know that's less of a hot take than people would like probably on both sides. But the reality is that just managing your balance sheet well and understanding your liquidity as a bank so that you can always survive to fight the next day is probably your single most important job. And when you do a poor job of it, especially in a high-risk industry, regardless of which industry that is, you're going to have a lot of problems. Let's zoom back out to the wider world of banks who are also experiencing this problem. There's something like $650, $675 billion of

unrealized losses on bank balance sheets right now. On Sunday, the Fed announced not just sort of these specific sort of depositor protections, but also a new Fed lending facility so that theoretically, banks can borrow against the full value of these underwater bonds rather than sort of the market value if they were to go out and have to sell them. One, I guess, what do you think about that Fed facility? Was that, you know, surprising to you to see them go there? And then two, you know, what do you think about, you know, obviously since that was introduced, now the debate is raging around. Is that a new type of moral hazard? Does this mean bank risk departments are just going to assume that all deposits even above $250K are insured, et cetera, et cetera.

So I would say, one, I wasn't that surprised by that facility. There were similar things that existed in slightly different forms because the problems were not identical, but they do rhyme in 2008, where essentially what you're saying to a bank is, look, just give us the collateral you have and we'll lend you money on some terms that aren't going to bankrupt you to lend you money on those terms at so you can continue as a going concern. This is essentially just the interest rate version of that. So it's not surprising to me. If you were a regulator who thought a lot about systemic stability, I think this is a pretty logical step. Two, on the moral hazard note, no, it's definitely not going to have that

effect in terms of the people actually sitting at banks so long as you continue to wipe out the equity and some of the debt holders. Because if I'm in a bank and I say, well, all these deposits are insured, so I'm going to do incredibly risky things with them. And if it fails, I'm going to go bankrupt personally because all of my equity went to zero. Well, hold on. That's the same situation I was in before this, right? This is back to my commentary on understand what a bailout really is. When you wipe out the employees and you wipe out the shareholders, they don't really have a huge incentive. Their sort of risk-adjusted return is largely unchanged. What it's done is changed the risk-adjusted return for depositors. With that said, nothing that happened here really

solves the net interest margin compression issue. And I think what we're going to see is, instead of like in one big bang moment, you're going to see a gradual shift of depositors from poorly managed banks with bad NIM to banks that can offer a higher interest rate on deposits, because if you want to gather deposits right now, you raise the rate you're paying. A lot of your competitors are trapped, then you're going to suck deposits out of them and into you. And then if those guys collapse, you're going to get to buy them for a song because that's how FDIC receivership works. So what we're going to see here, I think, over the next whatever period of time is basically the strong hands who managed their risk well increasingly empowered and probably some of the smaller and less sophisticated guys who did not are systematically going to die, which is why I raised the comparison to S&L, where that was a crisis more concentrated in small banks as opposed to like the extremely large ones. What are sort of the best case and worst case scenario for, you know, the next few months from where you sit?

So I think best case is that Congress takes this as a sign that they actually need to do something here. We get some clear legislation that establishes, you know, within some reasonable set of boundaries, rules of the road for dealing with crypto in the United States. And then hopefully we can take this as a near miss that was a learning moment and that will be off to the races on building something, quite frankly, more safe and sound than what's existed in the crypto industry previously. I think the worst case is that we continue to muddle along on the current path and are unable to change direction. And what happens is that systematically over the next two years, we end up offshoring the overwhelming majority of the crypto industry and that even worse, other jurisdictions do a good job of handling it because then once things really achieve critical mass and start building there, even if we get it right later on, there's no guarantee it comes back, right? We're kind of in that position with the semiconductor industry right now from a national security

perspective. So to me, that's really the worst case scenario from a crypto perspective. Obviously, from a banking perspective, it's mass collapses of lots of banks. But I think with the actions we've taken, it's more likely we'll have a series of call it orderly to semi-orderly small demolitions than like a big bank collapse. Super interesting stuff, Austin. Really, really great to have a chance to dig into this with you. hopefully this is a useful exercise for people who are, you know, trying to wrap their head around

everything that happened. But great to have you in the show and look forward to having you back again to check in on all this. Yeah, thank you very much. I enjoyed it a lot. All right, guys, back to NLW here for a quick wrap up. It has been an intense couple of weeks. In those couple of weeks, many of the most important battles that face crypto as an industry have been laid bare. I have been, as so many have righteously angry at what seems like and what feels like the injustice of the way that the U.S. banking establishment has systematically pushed to de-platform crypto. But I wonder to what extent it's time for us to start to rally now as an industry and put together our sense of what type of rules there should be around banking crypto in the

U.S. Are there common-sense things that we can agree upon that would make banking the crypto industry safer and would actually be useful to the growth of the industry, hold aside any benefits that it may have for regulators. In other words, could the crypto industry come up with a set of common sense rules that could then be enshrined in legislation? Now, of course, the counterpoint to this is exactly what I talked about with Austin in that there should not be the ability for the banking sector to discriminate against a legal industry.

And so perhaps writing specific rules just creates an utter balkanization that leads back to the same point, with banks making the financial decision that it's just not worth it. These are the types of debates we need to be having now and having in earnest. Anyways, guys, hope this was useful to you, and I'm looking forward to hearing your feedback. Thanks to Austin for joining the show, and until tomorrow, be safe and take care of each other. Peace.