The crypto industry’s response to traditional bank bailouts: A supportive ally?

In the beginning, the enthusiasm for crypto was based on the idea of cutting out the rigged banking system and allowing people to exchange goods and funds freely. However, as digital assets become more involved with the financial market, this idea has lost some of its significance. Despite recent bailouts of failed institutions such as Silvergate Bank, Signature Bank, and Silicon Valley Bank, the crypto community has not expressed any concerns.

 In fact, the United States Federal Reserve System’s intervention helped Circle, the issuer of USD Coin (USDC), which had a significant portion of its reserves in these banks. If the Fed had allowed these banks to fail, the crypto market would have experienced a significant downturn instead of the recent resurgence.

 This raises the question of whether the crypto industry has become too reliant on traditional banking and can no longer position itself as an alternative. Is it desirable for digital assets to be so interconnected with traditional finance, or should the industry create some distance from it?

Was the recent intervention a bailout?

Although both Silicon Valley Bank (SVB) and Signature Bank were technically bailed out, economists are pointing out a significant difference between the current situation and the U.S. government’s response to the economic crisis in 2008.

Treasury Secretary Janet Yellen explained that during the 2008 financial crisis, investors and owners of large banks were bailed out. In contrast, this time, it was depositors who were protected by the Deposit Insurance Fund, which is supplied by the banks and not by taxpayers. The Federal Deposit Insurance Corporation (FDIC) has guaranteed all deposits at both banks beyond the usual limit of $250,000 per account.

However, it was only due to the FDIC’s support that Circle was able to withdraw the entire $3.3 billion deposit from SVB and prevent further depegging of USD Coin (USDC).

US enforcement agencies are cracking down on crypto-related crime, which may seem peculiar for an industry that has traditionally been anti-establishment and even anti-Federal Reserve. It raises questions about whether the industry is taking federal backing for granted or even advocating for it. As the crypto community overlaps with the startup community, there has been a lot of support for bank bailouts.

Daniel Chong, CEO and co-founder at Harpie, believes there is no dissonance here and that it is possible to be a Traditional Finance (TradFi) skeptic while supporting startups to continue their operations and pay their employees. While a bailout may oppose the DNA of the crypto community, Tony Petrov, chief legal officer at risk management platform Sumsub, believes that it is crucial to try and rescue valuable institutions on the border of crypto and fiat, given their scarcity.

Bailouts have a negative connotation not only in the crypto community. In some instances, it seems like billionaire executives are receiving taxpayer-funded handouts in exchange for their poor decisions. The “too big to fail” mentality enables ineffective and poorly run banks to persist, even if they don’t provide any real value to the society in which they operate.

 However, expert acknowledges that what happened to SVB, Silvergate, and Signature was a clear example of mismanagement solely on the side of the banks’ executives. They invested in government notes rather than risky digital coins with unpredictable value. Therefore, it can be argued that the US government bears some of the responsibility for the outcome.

Examining crypto’s culpability in recent events

According to Ahmed Ismail, CEO of liquidity aggregator Fluid, the recent panic among crypto investors following the FTX incident contributed to depleting Signature Bank’s crypto deposits, but the bank’s underlying problems were much deeper. Signature Bank catered to a tightly knit set of customers, mainly startups and their investors, and aimed for rapid growth without diversifying its business or clientele, which ultimately made it susceptible to a domino effect.

Tony Petrov also disputed the notion that crypto was the sole culprit for the banks’ collapse. He pointed out the common problem of Silvergate and SVB, which was their faith in U.S. Treasuries, and the Federal Reserve’s interest rate hike dropped their value, coupled with the turmoil at SVB leading to a bank run.

 Moreover, there is an argument that the interconnectedness of the crypto industry with the banking system, particularly the extreme limitations of that connection, is eroding its financial stability. Daniel Chong, CEO and co-founder at Harpie, observed that the crypto market has been backed into a corner of the traditional banking system, with only a handful of entities willing to bank with crypto companies. The few institutions willing to do so end up becoming “crypto banks” by default, concentrating all the risks inherent in these fast-moving markets in a few institutions.

The crypto industry is facing sudden dangers due to its reliance on banks, and there seems to be little it can do to escape this paradox. On one hand, if cryptocurrencies become the primary means of exchange and accumulation, they won’t need banks.

On the other hand, the only way for them to get there is through their interchangeability with fiat money. Thus, to Petrov, building a fence against traditional finance looks counterintuitive, as demand for exchangeability remains high.

According to Oliver Chapman, CEO of supply chain specialists OCI, the crypto industry cannot distance itself from traditional finance without becoming insignificant or posing a systemic risk. Finance is important, and whether it’s traditional, crypto, or a combination of both, when things go wrong, there is a danger of a systematic crisis leading to a global recession.

While an independent crypto world remains a libertarian promise, it’s clear that there is no distance between fiat and crypto, as they are interconnected like the venous and arterial circuits in a human organism.

What actions can be taken?

The crypto economy can enhance its performance without competing directly against traditional finance institutions. By eliminating cost-bearing intermediaries, the crypto industry has already made finance more accessible and cost-effective.

Additionally, the use of cryptography and smart contracts in decentralized finance has improved security without compromising efficiency. Ismail believes that there’s no inherent conflict between traditional finance and the crypto economy, and both can coexist without the cost of the other.

However, Chong disagrees with this viewpoint, suggesting that we’re likely to see a lot of value being moved on-chain due to the recent collapses within traditional finance systems. The question now is whether the crypto market is ready to serve as a safe alternative to banks, especially with its own wave of devastating collapses in 2022.

 For the crypto industry to become a viable alternative to TradFi, it needs to establish some standards for managing corporate assets. Currently, only crypto-native engineers have a chance of keeping blockchain assets secure, which is not a scalable solution.

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