With the collapse of the Terra/Luna ecosystem, there’s a renewed interest in so-called stablecoins and the different approaches to building them. But why are they so hot in the first place? And how does the stablecoin business actually work? To learn more, we spoke with Alan Lane, the CEO of Silvergate Bank, a publicly traded bank that offers services to the crypto industry, including stablecoin issuers. The transcript has been lightly edited for clarity.
Points of interest in the pod:
Why Silvergate got into crypto — 5:24
How it dealt with regulation early on — 7:14
What services the firm provides stablecoin issuers — 13:23
What should back stablecoins? — 35:16
Regulatory concerns with stablecoins — 42:49
Joe Weisenthal: (00:11)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:17)
And I'm Tracy Alloway.
Joe: (00:18)
So Tracy, you know, we recently had the collapse of the stablecoin UST. Total disaster. It didn’t turn out to be a particularly stable coin in the end.
Tracy: (00:32)
You're not gonna say it. You're not gonna say unstable coin. You're so close. So close to, to saying the cliche. Yes. So Terra/Luna collapsed and that kicked off, I would say soul searching, maybe not soul searching.
Joe: (00:48)
I think soul searching is a fine word.
Tracy: (00:52)
Well, a vast amount of criticism of the stablecoin space and we saw some other stablecoins, 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 stablecoins sustainable? Are they inherently susceptible to some sort of bank run like phenomenon? And then secondly, is this whole Terra Luna collapse going to expose the sector to more regulation? Is there gonna be even more attention trained on this?
Joe: (01:26)
Right. Because there are different models of stablecoins. So this is really important. There are stablecoins where an issuer has a dollar equivalent of assets in a regulated bank. There are stablecoins in which the issuer has (in theory) a dollar or more than a dollar's 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 work through magic.
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 gonna get interested. And of course we saw in the financial crisis that one of the source of instability was money market mutual funds, which were supposed to stay at a dollar. 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.
Tracy: (02:35)
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 this space.
But the other thing I would say is, this is why when people say, oh, Terra/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 gonna be worth a dollar” Then 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.
Joe: (03:25)
Absolutely. Like that to me is the key thing, like, okay, yes. At some level. People can learn about the smart contract risk and they can learn about, you know, what theoretically is or isn't backing the coin. But if you call something a stablecoin, and it falls, that seems like a problem. So we need to learn more about this space. And the other question I have is like, why is the space 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 question.
Tracy: (03:54)
Also also to get away from fiat dollars, right. And instead of getting away from it, it seems like we've just created this shadow banking system, almost like the eurodollar market, just to create more dollars that are pegged to dollars. Anyway, I have so many questions. Let’s get into it.
Joe: (04:10)
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 stablecoin is. It is this attempt to sort of like bridge, okay, you have the us dollar and you have crypto and you sort of make a crypto version of the US dollar. We're gonna be talking to someone who has a great viewpoint on that. We're gonna be speaking with Alan 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 stable coin space. So we're gonna get all into the business of stable coin. So Alan, thank you so much for joining us.
Alan Lane: (05:00)
Yeah. Thank you for the opportunity. It's great to be here with both of you.
Joe: (05:03)
Alan 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 to the US dollar.
Alan: (05:16)
You're referencing the, the number go up meme, right...
Joe: (05:22)
What’s the point of a coin that doesn't go up?
Alan: (05:24)
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 US dollar and, and making sure that anytime any of our customers show up 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, right? 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, and happy to talk a little bit about that. But I don't wanna derail the stable coin conversation.
Tracy: (06:39)
I'll take you up on both those topics. So, you know, a regulated bank interested in the stability of the US dollar and presumably, you know, relatively interested in kind of boring investments. You got into crypto in 2014 when stablecoin 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, is the opportunity there for you when it comes to stablecoins?
Alan: (07:17)
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 the meme was with Bitcoin that you could be your own bank and, you know, being a career banker, I thought that was interesting.
And so as I went down the Bitcoin rabbit hole, as they, as they say back in 2013, I was really intrigued by this concept of, um, the fact that Bitcoin had a fixed supply. You know, we're talking a little bit here about the stability of the US dollar. And we know that the Fed’s mandate is to try to maintain inflation of around 2%. 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 US dollar, the fact is US 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 have. That's, that's probably every Bitcoiner’s thought no matter when you get in, but the fact of the matter is at once we got into the ecosystem and we were trying to help our customers. So the first thing we did Tracy is, 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. Uh, 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 SecondMarket. They were enabling some of their customers to, you know, to buy and sell Bitcoin.
And we went deep on this early. So, um, you 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, um, are deemed to be money service businesses. And so what we would do is when, when Genesis then called SecondMarket 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 sending a hundred thousand dollars to buy or sell Bitcoin, we wanted to go out to the blockchain and see that there was in fact, a transaction that represented a hundred thousand dollars of value. And I think at the time, SecondMarket was somewhat amazed that this.
This bank in Southern California was actually asking you know for blockchain addresses. And I think we have a pretty deep understanding of, 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, um, 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 Kraken and FTX.
And, you know, as soon as I start naming 'em, I'm worried I'm gonna let 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 US dollars and, and now euros. We launched the, the Euro SEN 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 US dollars amongst themselves around the ecosystem anytime, 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, um, Monday through Friday into the 24/7 digital asset market that trades around the clock around.
Joe: (13:01)
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. What value do they get from Silvergate?
Alan: (13:23)
Yep. So they use the SEN and our API for 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 US dollar and other fiat currencies into the Bitcoin and digital asset market.”
And then likewise, we are the offramp from that the digital asset market back into fiat currencies and the way that's done. And so let's talk about the stable coins, uh, the stablecoin issuers who use our platform. So they are all of the regulated US dollar backed stablecoin issuers. And, by that distinction I heard in your opening remarks, you were, you were distinguishing between the different types of stablecoins. The dollar backed ones are the only ones we back. So we don't bank bank, the algorithmic stable coin offerings, nor do we these other, you know, stable coins that are maybe collateralized by other digital assets. They don't need a US dollar bank because they're not backed by US dollar.
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 USDC. 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, 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 Paxos Dollar, which is issued by Paxos for the Gemini Dollar issued by Gemini and for TrueUSD. They use the SEN and our API for the minting and burning of their tokens. So those tokens are issued when a dollar hits their Silvergate bank account, and it's all programmatic. And so if, 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 institution that is looking to purchase the USDC. And then the same thing happens in reverse. If someone wants to redeem their USDC and go back to us dollars, they send the USDC to, to the wallet at circle circle. At that point, once they have possession of the SDC, they then send an instruction to us via API. And we then in turn will send the dollars back to that prior U SDC token holder.
Tracy: (17:05)
So can I ask a broader question about the space? Is there an irony here that, you know, a lot of crypto is sold on the basis that 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.
Alan: (17:47)
So again, an important distinction though would be that these entities that we're banking aren't operating outside of regulations. 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 my thought process was, well, if this takes off it's going to take years. It's gonna 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 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 sovereign government's desire to issue their own currencies. And so I view Bitcoin, as you know, you guys are very familiar with the name, digital gold, you know, it is a way to save a portion of, of, 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, some people might, 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 kind of have a foot in both ecosystems.
Joe: (19:37)
So you are the owner of the assets that were Diem. So Facebook for a few years, I think starting in 2018, they tried to get their own stablecoin off the ground is gonna be sort of a global. It just never really worked. Why couldn't it? What was the problem from your view? Why didn't that work? And what constitutes the assets that were left over that you've acquired?
Alan: (20:03)
Why it didn't work? Unfortunately I think it's because it was Facebook. You know, I will say early on, I think you, you know, they kind of raised the ire, not just of the US government, but a lot of governments when when they announced that they were going to issue this and make it abacked by a basket of currencies.
So it's like, let's not only, you know, upset the US 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 basket, you know? So I think they quickly realized that it needed to be backed by a single currency. Unfortunately by that time, you know, I think they were just in the cross hairs and no matter what they did, you know, they tried to move offshore.
They were a Swiss entity for a while trying to issue a US dollar-backed token that. You know, if you just stop and think about what I just said you know that's gonna be problematic. A Swiss entity issuing a US dollar backed token. And so, you know, there are a lot of challenges, but at the end of the day, what, what we saw as the opportunity, and I should mention, we were not involved with Facebook at all during any of that. Okay. We ended up coming on the scenes late.
So they had, as, as you'll know, just remind you that they started out as Libra. They then switched the name to Diem. They then moved to, um, 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 USDC and some of the other early entrances. 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, we've got this SEN. The Silver Gate Exchange networks.
So a lot of our customers are using the SEN to transact dollars 24/7, but that's not on a blockchain. It doesn't, candidly, it doesn't need to be. To do in intra bank transfer. But if they wanna take their dollars outside of Silvergate, well, then oftentimes what they were doing was they were starting on the SEN. They were then buying USDC 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, you know, 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 Diem 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 gonna hold the reserves, but you know, each of them was gonna hold 25% of the dollars backing these tokens. So you're gonna have 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 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 stablecoin because we saw the value in, in helping our customers have a dollar token that could be used in the crypto ecosystem.
But what the Diem 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 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, and so that was our thesis going in. And so we said, yeah, we'd absolutely like to be a part of this. As we worked with the Diem association over the first six months of 2021, it got to the point where they abandoned that multi-bank kind of approach.
And we announced in May of last year, May of 2021, that Silvergate was going to be the exclusive issuer of the Diem’s dollar. And that was, you know, that was at, at the time, um, a big deal for us. And obviously we thought that we saw a path to us participating and, you know, partnering with them to issue the Diem, USD unfortunately 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 US 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, you know, to address the potential regulation for stablecoin. 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.
Tracy: (26:16)
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 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. Um, if you go out and do it, like often you, you just kind of get away with it. So I I'm curious what those conversations are, are actually like.
Alan: (26:52)
It's a fair question. And you know, at times some of our investors have asked us the same question, “Well, why don't you just, you know, launch something?” Well, I think there's a big difference between a regulated bank that is already operating under the authority of these regulators.
These different regulatory agencies versus a tech startup, that's gonna spin something up and launch it into the market. But to your question of what's it been like, you know, our, our regulators have really come up the learning curve. I mean, we've been doing this now, as I mentioned for, 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 SecondMarket 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 guidance for how a bank should interact with the money service business. What we did was 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 and the Fed. And I asked the question if they had heard of Bitcoin and they were thinking about it well, is that kind of like, um, you know, banking marijuana companies? So it was kind of all, you know, it was very unclear, but, um, I, I could show you the presentation.
It was like an 8-page or 14-page presentation. This is what Bitcoin is. And these are the types of companies that are being formed. This is the SEN 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, that we're doing.
I'll just mention one other thing off-topic, but we also offer loans collateralized by Bitcoin. And that was a, that was another path that we went down, um, 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 ‘em how we were thinking about doing it. All the risk mitigants that we had in place. We launched a pilot in early 2020. We 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 SEN leverage commitments (we call the product, SEN 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 Diem and I wanna tie in the last part of your question, which was “okay, we bought these assets what, what did we buy and what do we plan to do with it?” So when the president's working group report was issued in November, first 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 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 breathe a 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 strongly encouraged us to wait until this guidance came out. And once the guidance was out, it was pretty clear that if we had launched with Diem, we would have then been operating a stablecoin 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 Diem folks read the report, they were looking at that and, and we called them up and we said, well, what do you guys think? And they said, yeah, you know, we think we're gonna pause this effort. Looks like we're kind of dead in the water, my words, not theirs. And so we're gonna engage strategic advisors to help us figure out what to do with Y 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, 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. Um, we had done all that work to integrate with them. And so we looked at the tech and, and we said, you know, this is actually purpose built for payments. They, they had some of the, you know, 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, let's see if we can acquire this technology. And, and then, you know, 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, um, we bought the, the protocol itself, which is open source.
And, you know, some folks have said, well, gosh, what did you really buy? Cuz 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 transactions. 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. Um, so buying all of that together in furtherance of then us being able to issue our own stablecoin and again, for the use of payments and remittance and not for a cryptocurrency use case.
Joe: (34:10)
So I wanna ask another regulatory question, which is what in your view should back stablecoins. Should they be entirely, in, say short term Treasuries? Like one to one? Because this is a big question. And then also if there is gonna 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 risk of contagion to the broader financial system, if in a crypto crash and people wanna pull out stablecoin issuers have to liquidate some of their assets rapidly. I know you're not in the business of actually holding them because as you talk the assets, because you're in the minting and burning of stablecoins, nonetheless.
I wanna get your take on if I buy a stablecoin, 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, uh, you know, uh, into the, yeah. Into the broader, uh, financial assets.
Alan: (35:16)
Yep. Great question. And we think a lot about this because candidly we treat, SEN and all. I don't think I've mentioned this yet, but we have over 1500 institutional customers at Silvergate. Okay. In this initiative who are using the SEN every day.
And as an example in the first quarter of 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. Okay. That was actually down quite a bit from the fourth quarter. 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 as is that we, we have a very large investment security 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. 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 importantly, they all trade actively, you know, the types of securities that we buy that 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, you know, we're gonna 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 and we actually encourage our customers to only keep as much at Silvergate as that they need for their trading and investing activities.
You mentioned Joe that, you know, that we don't hold all the reserves for USDC for instance. USDC is over 50 billion. We're only a $15 billion bank and we have 1500 customers. So obviously, yeah, we don't have the majority of those dollars. They are spread elsewhere in the banking system. And there are other banks that have, obviously, since we got into the space or other banks that are banking, this, this crypto space, um, 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, and we thought, heck this is a potential source of deposits yeah. To fund 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, you know, I think they're primarily using those in, in some of their lending operations.
And again, um, that 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 stablecoin, you know, you, you can imagine that we might have seen heightened activity yeah. Across our platform the industry relies on us for that critical function.
Tracy: (38:55)
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 Terra 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, 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's sort of, it feels like it feeds on itself at certain times.
Alan: (39:46)
What I can say about the way we are set up at Silvergate is because we are not the bank that is holding the reserves we technically don't. 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 deposits. Let's make 'em 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, and so what that means Tracy is, is that when, um, when there's this type of activity, we see a lot of money going through our bank. But, um, but we actually see our deposits.
I talked about this on an 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. 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 are already seeing deposits kind of normalize. And we reported on that fact, but critically, we are this critical you know, piece of infrastructure where, 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 gonna put 'em.
Sometimes it just ends up at USDC. In which case those dollars, aren't gonna sit at Silvergate, they're gonna sit in in reserve, but they might pass through us on, 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, of liquidity and stress, you wanna make sure that you're not investing those, those, those funds, um, you know, into something that's more long term because you don't know how sticky it's gonna be.
Joe: (42:11)
I just wanna 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 USDC. I don't know if it's had to actually, uh, liquidate or if people are just hanging 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 feel, you know, it's day one, like, is there risk of crypto market volatility forcing liquidations in other assets and therefore spreading volatility elsewhere into the financial system?
Alan: (42:49)
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 this points of liquidity, stress. etc. um, which is, which is candidly. One of the reasons that, that, that we think, you know, from our perspective, and I'm not, you know, hey, I'm a free market guy. Clearly USDC has found product market fit.
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, and they're speaking with their wallets and there's over 50 billion you know, backing USDC right now.
What we see is that there is a, 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, um, or let, let's say a 20, because, you know, you, you typically can only get twenties outta the ATM, right? So if I go to the ATM and, 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, that is the place for a Silvergate-issued tokenized dollar. And, 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, we're getting away from calling stable coin. because obviously stable coins have a really bad name, um, because, um, they've proved themselves to not be stable, um, in many cases. Um, but, but for us, we're looking at this as, hey, this is a tokenized dollar, right, right now on my iPhone, I have both the dunking 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 you know, I can't take my dunking donuts app and pay for a coffee at Starbucks. And so, so what we see, and this is a longer view, and it's gonna take a while to get there, but everything in the world is moving digital. Um, and people say, well, money is digital too. And that's true for all of us in the first world, but there are, um, there are many people that don't have access. They all have phones, right.
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, um, at a physical merchant. Um, and so that's that, and, 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.
Tracy: (46:30)
So Tether, okay. Clearly controversial in many ways, there have been questions swirling around what exactly is backing it. Uh, 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, are moving or not moving. So you described, for instance, when we had the big run, uh, 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 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?
Alan: (47:37)
Unfortunately my knowledge is limited. Just as the rest of the 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, 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 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. But I do know that when we talk to our customers, cuz we've asked them, you know, well, 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 until there is actually something that causes them to burn through all their cash and then their securities and then, you know, theoretically their commercial paper — it just works. And, and there are, by the way also use cases that I've heard of where, where people in other countries who want to hold US dollars because they might be in a country that, that is experiencing hyper inflation. They're comfortable. Um, and these are like consumer folks. They are comfortable holding Tether as a dollar proxy. And you know, I, I don't know that how widespread that is, but I've certainly heard that
Joe: (49:26)
Alan, 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. Cuz I think like stablecoin design stablecoin regulation. The business of stablecoin is not going away anytime soon. So I appreciate you coming on unlocked.
Alan: (49:54)
Yeah, I really appreciate the opportunity. It's um, I, I'm happy to come back anytime. Um, great. I absolutely love this space and, and, uh, appreciate all the work that you guys are doing.
Joe: (50:04)
Thank you. Take care, Alan.
Joe: (50:18)
You know, what was interesting, uh, was that Ellen said that they might think about rebranding stable clients, that it is seemed like it's kind of gotten tarnished because on the one hand you have Terra/USD, 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 gonna launch something, maybe that's smart, like call it a tokenized dollar or something else. Cuz I do think it's sort of a dirty word at this point.
Tracy: (50:48)
I, 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?
Joe: (51:00)
Yes. Yeah, absolutely.
Tracy: (51:01)
Okay. So peer to peer lending, this whole idea that, uh, 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, um, so that's 0.1. And then secondly, they also rebranded, uh, 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 remind, it reminds me a lot of that space.
Joe: (51:36)
That's, that's a, 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 like 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 tethers versus the outside skepticism. It's like this huge bid ask spread. So to speak on tether as a concept,
Tracy: (52:04)
I mean, it would be pretty amazing if all of tethers problems just boil 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. Um, 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, uh, are extremely skeptical.
Joe: (52:35)
Yes. But on the other hand note that 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 on there and not necessarily bad per se, but there's a reason, you know, Silvergate is not a Tether business partner.
Tracy: (53:02)
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 the 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, I don't know then, then maybe that does lessen some of the pressure. But of course the question is whether or not you're sort of, um, abdicating your original use purpose.
Joe: (53:38)
I also think this question of like, okay, if something is gonna be called a stable coin or whatever it is, there's gonna 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 sorts 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 how, what they, 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 gonna need to just get like clearer answers on.
Tracy: (54:30)
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 gonna 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?
Joe: (54:49)
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, cuz it really is like pretty big to thinking about the future of crypto.
Tracy: (55:00)
The stablecoin rabbit hole. It's also just interesting from the perspective of what is money and what is a financial asset and what makes something safe and contagion effect. And anyway, yes, you're right. Okay. We should stop. Should we leave it there?
Joe: (55:12)
Let's leave it there.