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Banking Instability; Rep. Emmer's Letter to FDIC; EU Smart Contract Legislation

Banking Instability


Silvergate


Last week, Silvergate Capital announced it would “wind down operations and voluntarily liquidate [Silvergate Bank]...in light of recent industry and regulatory developments” a week after announcing they were discontinuing the Silvergate Exchange Network (SEN)—a 24/7 settlement network.


This downfall was triggered in large part by FTX and Genesis pulling their funds following their own collapses. After Silvergate delayed its annual report and disclosed its solvency concerns in recent devastating SEC filings, other crypto giants, including Coinbase Global, Galaxy Digital, Paxos, Circle, Gemini, and Bitstamp dropped Silvergate as their banking partners, further plunging it into a crisis.


Unlike Silicon Valley Bank’s downfall, Silvergate did not rely on government assistance and shareholders took the hit of its 83% drop in share price since March 1st and not depositors.


Silicon Valley Bank (SVB)


SVB experienced their own bank run when word spread of their insolvency—meaning they were unable to pay their debts when they were due. SVB, like most banks, is a fractional reserve bank, where they are only required to keep a fraction of their deposits on hand and lend or invest the rest.


A majority of SVB’s deposits—$100 billion—were in US Treasury bonds—loans to the US government to fund their operations. Theoretically, these are supposed to be safe bets but because the Federal Reserve hiked interest rates faster than anticipated, the bonds lost value quickly and SVB was looking at a serious loss—$1.5 billion, to be exact. This was unsustainable with the amount of money being withdrawn by their clients and SVB sold securities at a loss and announced they would sell $2.25 billion worth of shares.


Unfortunately, their stock dropped 60% after word spread of insolvency and the bank run spurred before they could raise capital. Consequently, the California Department of Financial Protection closed SVB and the Federal Deposit Insurance Corporation (FDIC) announced its involvement to allow depositors to withdraw their money; however, the FDIC specified that “shareholders and certain debt holders will not be protected.”


The FDIC has begun auctioning SVB to other banks.


Signature


On Friday, following the Silicon Valley panic, customers of Signature Bank withdrew $10 billion in deposits, which provoked the New York Department of Financial Services to close Signature Bank’s doors. On Sunday, the FDIC announced that they were also getting involved in Signature’s operations to make depositors “whole” again.


Signature is now being auctioned off back to the private sector. Interestingly, anonymous sources have informed Reuters that “any buyer of Signature must agree to give up all the crypto business at the bank.” This sentiment was quickly refuted in updated reporting according to a FDIC spokesperson..


What does this mean?


As it pertains to the cryptocurrency ecosystem at large, there are a few implications that came from these bank runs.


First, Silvergate’s downfall increased banking concentration risk and put pressure on the few remaining crypto-friendly banking partners as former clients fled with assets in hand. The discontinuation of SEN also barred access to the rapid liquidity provided to clients.


Second, USDC issuer, Circle, tweeted Friday night that $3.3 billion of the $40 billion in USDC reserves were held in SVB and that they were unable to withdraw their balance. This led to panic that depegged USDC and dropped its value below $1. As of March 13, Circle announced that the $3.3 billion held in SVB was “made fully available and transferred to new banking partners.” USDC is back again at $1.


Third, if you or anyone in your network knows of any individual or organization who has been de-banked as a result of being associated with a crypto business, please reach out to debanked@theblockchainassociation.org


GOP Majority Whip Claims Financial Regulators Have “Weaponized” Recent Instability Against Crypto


What Happened?


Wednesday, House Majority Whip Tom Emmer (R-MI) sent the Federal Deposit Insurance Corporation (FDIC) Chair Marty Gruenberg a letter that expresses concern over the “Administration’s demonstrated effort to choke off digital assets from the United States financial system,” in response to the recent closures of digital asset-centric banks, including Silvergate, Signature, and Silicon Valley Bank.


In the letter, Rep. Emmer criticizes the FDIC’s lack of proper procedure when publishing its statement that discourages banks from holding crypto assets on a “safety and soundness” basis in the Federal Register.


He also criticizes the Biden Administration for “lawlessly abus[ing] the Administrative State to push American Crypto firms, and their American customers, into offshore, unregulated, opaque, and unsafe markets.”


Finally, Rep. Emmer posits three major questions to the FDIC:

  1. Has the FDIC instructed banks under its supervision to not provide crypto firms banking services?

a. If yes, please explain the analysis for this instruction.

b. Please explain, in your view, the goal of the instruction if not to discourage banks from servicing digital asset clients.

  1. Have you communicated - explicitly or implicitly - to any banks that their supervision will be more onerous in any way if they take on new (or maintain existing) digital asset clients?

  2. There have been allegations that these bank closures happened because crypto is "risky," when in reality these institutions appear to have been impacted less by the volatility of digital assets and more by the unprecedented interest rate hikes we have witnessed over the last twelve months. What, if any, guidance has the FDIC provided to financial institutions to help them manage and mitigate the risks of rising rates

What does this mean?


Representative Emmer expresses valid concern with the FDIC’s alleged attempt to block crypto firms from receiving banking services. The FDIC’s role in these situations is to protect depositors and maintain the stability of the banking system; it is not to influence business decisions of the acquiring bank or otherwise penalize legal US businesses.


In conducting the sale of a failed bank, the FDIC must do so transparently and we support Rep. Emmer’s letter to Chair Gruenberg to demonstrate that the FDIC is being fair and impartial in its duties. We look forward to his response.


The European Parliament Approves Legislation Requiring Smart Contracts to Include a Kill Switch


What happened?


On Tuesday, March 14, the European Parliament passed the Data Act to eliminate the barriers to data sharing within the European Union (EU).


Notably, Article 30 of the act describes “essential requirements regarding smart contracts for data sharing.” It mandates that smart contracts include termination mechanisms, also known as kill switches:


the smart contract shall include internal functions which can reset or instruct the contract to stop or interrupt the operation to avoid future (accidental) executions; in this regard, the conditions under which a smart contract could be reset or instructed to stop or interrupted, should be clearly and transparently defined. Especially, it should be assessed under which conditions non-consensual termination or interruption should be permissible.”


According to Thibault Schrepel, a legal expert in blockchain technology, the bill does not define “smart contracts for data sharing,” potentially making all smart contracts subject to the bill’s requirements.


The act also mandates that smart contracts have strong access control mechanisms and protect the confidentiality of trade secrets.


What does this mean?


Immutability is one of the core features of a smart contract. Among other things, it guarantees the execution of its functions without the need for intermediaries. While it is technically possible to design smart contracts that include kill switches, those too can be abused, and governments should not dictate how code is written as a general principle.

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