crypto strategy

Silvergate will be battle tested in the ongoing crypto bloodbath (NYSE:SI)

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I’ve been very bullish on Silvergate (New York stock market :IF). I see the company as a regulatory play on the bitcoin ecosystem, a way to gain exposure to bitcoin without being overtly dependent on Bitcoins (BTC-USD) price direction. The The company is taking advantage of the Bitcoin adoption trend by securing zero-cost funding from institutions using the SEN network. Silvergate then applies these funds to high-quality assets (primarily mortgage-backed securities, 97% AA- or higher).

However, one of the main drivers of growth is a bitcoin collateralized loan product that allows its customers to use their bitcoin as collateral for funding, the SEN Leveraged Loan. This is where the cracks start to show. The company publicly disclosed a margin loan to MacroStrategy, an entity owned by MicroStrategy (MSTR). Let’s see how this could unfold.

domino crypto

Right now, a crypto domino of bankruptcies is unfolding as we speak. It started with by Luna (LUNC-USD) the fall (the stablecoin algo), then spread to 3AC (the crypto venture capital fund) which was heavily leveraged, and ended with the fall of Voyager (OTCPK:VYGVQ) and BlockFi. We thought the effect stopped when Sam Bankman-Fried appeared in a white horse, buying some of the troubled assets. However, the fall of FTX is now causing concern across the crypto space and has rekindled the domino effect.

The million dollar question is who’s next? At this point, a big competitor is MicroStrategy. The company has benefited significantly from buying Bitcoin over the past couple of years. While the first acquisition is always lower than the current price, the next one costs more than Bitcoin is worth now.

Chart

MicroStrategy Bitcoin Purchase (Twitter: @Elementcapl)

In other words, from public information, we can estimate that the company purchased nearly $4 billion worth of Bitcoin at an average cost of around $30,000. At the current market price of $16,000, unrealized losses represent almost 50% of the total position. The company might be able to cover the collateral on the margin loan and continue to service the loans until the first maturity, and it might survive, but it got itself into a tough spot.

Obviously, the current problems will not end with MicroStrategy. It’s just one of the best known names in the industry. Others will probably fall too. Players used credit in illiquid markets, but more importantly they used leverage on a highly volatile asset like Bitcoin. Ironically, in previous bankruptcies (such as 3AC), it appears lenders using smart contracts in crypto platforms have automatically recouped their loans. However, in these cases, loans made through traditional financing will have to wait for the bankruptcy courts to try to recover something.

Impacts of crypto domino on Silvergate

The most direct will be the ability to protect MicroStrategy’s margin loan from losses. The loan has plenty of collateral and is likely to be fully collectible. However, the uncertainty is higher than ever. Not losing money in these SEN leveraged loans will serve as a proof of concept for the entire business model. According to the company’s financial information, Silvergate has 9% of its balance sheet in direct loans:

Circular diagram

Silvergate Asset Allocation (Silver Gate)

Of which approximately $300 million are SEN leveraged loans.

table

loan portfolio (Silver Gate)

Conclusion

However, even if Silvergate does not lose money in loans, it will not come out unscathed. They will lose customers in the SEN. FTX will be gone, and rumors are now circulating about Crypto.com (USD-CRO) also facing a race. silver gate issued a statement claiming that the relationship with FTX is limited to deposits, corresponding to less than 10% of the 11.2 billion total deposits.

Table

SEN (Silvergate)

Silvergate has traditionally avoided using all of its crypto repositories in its business. If this conservative approach proves effective, it will be good for the company in the current turmoil. Nevertheless, the market sees this as a weakness and downgrades the company’s growth prospects. The current market multiple already recognizes weaker growth and some acknowledgment of losses with a P/BV below one (stock price: $34.32).

If the company is able to hold on and avoid major losses on its credits, it validates the current management strategy and can constitute an interesting entry point. However, the uncertainty has never been higher due to the multiple unpredictable effects that the crypto drop of several involved companies could bring. The current environment is a huge stress test for Silvergate’s management strategy and execution.

The balance sheet reveals what appears to be somewhat contained exposure. However, the strategy for growth is highly dependent not on the price of Bitcoin but on the prosperity of the crypto ecosystem, and the fall of the domino will be a major headwind. Provided the company avoids losses and the crypto industry can push back, I think Silvergate will be a good investment. But both hypotheses will be tested over the next few months.

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