Amid Banking Crisis, Crypto Firms Call For Better Integration Between TradFi & DeFi

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Two of the crypto industry’s friendliest banks and the biggest financial services provider for the tech startup space all folded in less than a week. Those events shook the crypto ecosystem, sending the price of most digital assets – including stablecoins – down, only for the market to recover as the U.S. government stepped in to provide a backstop for the banks’ depositors. 

Nonetheless, the collapses of Silvergate, Signature and Silicon Valley Bank have left cryptocurrency startup founders scrambling to try and find alternative banking partners so they can stay in business. 

Trouble first began brewing on March 8 when investors, spooked by rumors of SVB’s lack of liquidity, started advising portfolio companies to withdraw their funds as quickly as they could. The rumors sparked a full-scale run on SVB deposits, and by March 10 the bank had been shut down by regulators. Prior to that, Silvergate had already told customers it would be shuttering its services to the crypto industry, and two days later, Signature Bank also shut up shop following a run by its own customers. 

A Forced Marriage Between Crypto & Banks

Often viewed by traditional financial institutions as renegades, crypto startups have often found it hard to locate partners in the banking industry. It’s understandable because the crypto industry itself promises to disrupt traditional banks in a way that could cause them irrevocable harm. But for now at least, crypto firms still need traditional banking services for things like payrolls and providing on- and off-ramps for their customers. 

Because Signature and Silvergate were perceived to be so crypto-friendly, they were the first choices for hundreds of crypto startups that are now scrambling to find new deposit accounts and other critical financial services. The crypto conglomerate Digital Currency Group, for instance, admitted this week that the majority of its clients were exposed to Silvergate and left stranded by its exit, and has desperately been reaching out to dozens of new banks in an effort to locate new partners for them to work with. 

There have been claims that U.S.-based crypto firms are in an especially sticky situation as there are no remaining banks there that are willing to cater to them. That has since been proven false, with several users on Twitter pointing out that there are still plenty of options available, including some of the country’s largest banking giants: 

This is false. United Texas Bank, Western Alliance Bank, JP Morgan Chase, and Bank of New York Mellon all have crypto businesses as customers, and there are probably more. https://t.co/Q27bkzq2n8

— yuga.eth 🛡 (@yugacohler) March 13, 2023

Crypto Founders Must Hedge Their Bets

Nonetheless, while crypto companies are weighing up their options, they should use this opportunity to take steps to ensure that they never find themselves exposed to the risks of having all of their eggs in one basket again, said Kenneth Ballenegger, a partner at Oyster Ventures. He explained that there are two things that crypto founders should look to do to insure themselves against any potential problems in future. The first is to request that their existing banking partners allow them to deposit their assets in an insured cash sweep account. 

“Most banks offer ICS accounts, which are essentially accounts that distribute deposits across multiple banks automatically and transparently, thus giving customers full FDIC insurance on up to $100M in deposits,” Ballenegger said. “First Republic can set up an ICS account in 24 hours. For obvious reasons, many banks prefer to keep deposits on their own balance sheets, so they might not be so keen to offer an ICS account unprompted.

The other step is for founders to ensure they have some redundancy off of their own back, Ballenegger said. He advised crypto founders to operate with a minimum of two banking partners, if not more. 

Yusuf Sevim, co-founder and CEO of Metatime, a Turkish blockchain infrastructure startup, said his own VC partners had advised him to always have a long-term and flexible perspective when looking for banking partners. “So you need to consider factors such as the service quality, reliability and flexibility of your banking partners, as well as your company’s future needs and growth goals. 

A Return To Crypto’s Ideals

While crypto firms are looking to diversify their relationships with their partners in the banking sector, many industry watchers believe we will also see others trying to accelerate their departure away from traditional finance altogether. Instead of keeping their funds with banks, they’ll look to store more of their financial assets on-chain, where decentralization ensures that no one can pull the plug and prevent them from being accessed. 

Aaron Mathis, founding validator and developer at ReserveBlock, said the fall of SVB, Signature and Silverbank shows that centralized negligence and greed continue to rinse and repeat with the same traditional failures, echoing the similarities with the 2008 Great Recession

“In 2023, we should not be seeing people waiting outside of shuttered institutions desperately trying to gain access to their own funds,” Mathis said. “These failures are a reminder of the very credible argument as to why decentralized and trustless technologies have a place in the ecosystem and why we need to evolve with transparent tools and enable choice, sovereignty and true custody.” 

What’s likely to follow next is that we will see two divergent approaches to the development of crypto in future, said Baek Kim, a partner at venture capital firm Hashed. On the one hand, it’s likely that some startups will push towards a fully decentralized, privacy-preserving and custody-in-control approach, in which they hold and manage the bulk of their assets on-chain, he said. 

“This trend will be driven by a desire to reduce reliance on centralized authorities, increase individual sovereignty, and protect against potential breaches of privacy and security,” Baek said. “This development is likely to be particularly attractive to those who value the ideals of the original crypto movement.” 

Tighter Integration With DeFi & TradFi

On the flip side, Baek said we will also see other crypto firms pushing to redefine fully compliant and regulated financial rails for the highly volatile and liquid crypto industry. This trend, he said, will be accelerated by the desire to bring crypto into the mainstream and increase its accessibility to the wider population while reducing the risk of fraud and market manipulation. 

“This development is likely to be particularly attractive to institutional investors and traditional financial institutions, who seek to capitalize on the potential of crypto while minimizing its risks,” Baek added. 

Some believe that the latter trend, towards more regulation and better integration of traditional finance and crypto, is the only viable way forward, at least for now. Circle Chief Strategy Officer Dante Disparte, speaking on the FinTech Beat podcast, said it’s clear that the crypto industry and traditional finance both still need each other. “There’s a co-dependency here… the industry and the responsible innovators and others need each other,” he said.

ReserveBlock’s Mathis agreed, saying that there is still clearly a need for on-ramps and off-ramps between crypto and the traditional financial system. As such, he believes it’s essential that the two systems find better ways to work with one another. 

“If we stop looking at things through a linear lens and integrate traditional platforms with decentralized technologies properly, we would more than likely see a drastic reduction of these types of failures and have real transparency and accountability,” he said.

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