First they ignore you, then they laugh at you, then they fight you. And then you win.
A mere 15 years after the fallout from the Global Financial Crisis inspired the creation of Bitcoin, a new yet eerily familiar crisis in the world of traditional banking is reminding us that the financial system is more fragile than many would like to believe.
The introduction of Bitcoin is shrouded in mystique — thanks in part to the anonymity of creator Satoshi Nakamoto — but its creation was a logical reaction to the events of the 2008 financial crisis. What we do know: The first appearance of Bitcoin came just two months after Lehman Brothers filed for bankruptcy.
The failure of major financial institutions, ranging from investment banks like Bear Stearns and Lehman Brothers to main street banks like Washington Mutual, shook people’s faith in the banking system. This loss of trust led to the advent of Bitcoin, creating the first decentralized peer-to-peer financial system, doing away with the need to place trust in third parties and intermediaries. This was a revolutionary development that allowed people to “be their own bank” and put individuals on a level playing field with banks for the first time. Rather than being asked to trust a centralized intermediary like a bank with their money, Bitcoin was trustless and allowed people to instead verify in its open-source code.
Between the Great Financial Crisis and the current banking crisis, Bitcoin also served as a safety valve during the Cyprus banking crisis of 2013, which spread uncertainty throughout Europe. This unease led European citizens to diversify out of euros and Russian rubles into Bitcoin, driving Bitcoin from US$93 to a then-all-time high of US$265 over the course of two months and making many people who were simply concerned about the safety of their savings into early adopters of Bitcoin. Market maker Cumberland notes that the Cypriot crisis preceded the current debacle by exactly a decade, tweeting: “Ten years ago this week, there was a bank run in Cyprus, where ATMs were emptied and vaults were depleted. This event triggered the largest-ever rally (in percentage terms) in BTC… This weekend, ETH and other cryptoassets joined BTC’s strong performance in the face of banking turmoil. History doesn’t always repeat itself, but it often rhymes.”
Since that time, Bitcoin has grown from an idea on a mailing list to a US$500 billion asset utilized by millions of people all over the world for a wide variety of purposes. Bitcoin and the cryptocurrency asset class that it helped to create have come a long way. But recent events show that the majority of people still have a long way to go when it comes to safeguarding themselves against the risks posed by the current financial system.
What Happened?/Death Spiral/Self-fulfilling Prophecy
In early March, traditional markets were rattled by news that Silicon Valley Bank collapsed. SVB was the sixteenth-largest bank in the United States with over US$200 billion in assets as of Dec. 31, 2022, making this the second-largest bank failure in U.S. history and the largest since the collapse of Washington Mutual in 2008.
Rumors of trouble began circulating late Wednesday, March 8 when SVB’s CEO said that the bank would be “rebalancing” its balance sheet by selling treasuries and raising new equity in the company. This, coupled with a downgrade of the bank’s debt by rating agency Moody’s, caused what can best be described as a death spiral or self-fulfilled prophecy. According to the Wall Street Journal, on Thursday, March 9, panicked customers tried to withdraw US$42 billion, giving the bank a negative cash balance of US$1 billion, leaving the bank unable to cover its outgoing payments at the Federal Reserve. Shares of SVB’s stock fell 60% that day, causing more panic and more withdrawals as some venture capitalists urged their portfolio companies to pull their money from the bank. By Friday, March 10, regulators had shut the California-based bank down and the Federal Deposit Insurance Company had taken over.
How did this happen? The tech-focused bank served many startups and VCs in the tech and biotech sectors, placing an outsized focus on these types of businesses. It saw a huge influx of capital during the years surrounding Covid-19 and the influx of financial liquidity that came with it. The bank invested much of this capital into U.S. Treasury bonds and other safe instruments like mortgage-backed securities. However, the Federal Reserve’s fast and furious cadence of interest rate hikes hit Silicon Valley Bank in two ways. The rising interest rate environment hurt tech companies, and many of Silicon Valley Bank’s customers needed to withdraw significant amounts of funds. Secondly, it diminished the value of SVB’s bond portfolio, which was invested at lower rates. New investment in tech and startups slowed down due to the tighter economic conditions, meaning new money wasn’t coming in quickly. SVB was forced to sell bonds before maturity at a loss to meet liquidity demands.
The fall of a large and established bank is startling for both its magnitude and the speed at which it happened. The fragility of a major, well-respected bank in the United States with over US$200 billion in assets should give everyone some pause. While there don’t seem to be any allegations of wrongdoing at this time, there does seem to have been poor risk management practices. At the very least, the Justice Department and Security and Exchange Commission are investigating the circumstances of the bank’s collapse. Alfonso Peccatiello of The Macro Compass explains that, with a US$120 billion bond portfolio and average duration of 5.6 years, every 10 bps move higher in interest rates caused SVB to lose US$700 million, and a 200 bps increase would cost US$14 billion, essentially wiping out all of the bank’s capital.
Many startups and venture-backed firms expressed concern they would not be able to make their payroll the following week, and Y Combinator CEO Garry Tan described SVB’s collapse as an “extinction-level event” for the startup ecosystem.
Single point of failure
That such a large and renowned bank could enter a death spiral like this at breakneck speed is a reminder of the importance of diversification — and the risks associated with being at the mercy of a single point of failure. As one customer told the Wall Street Journal, “We are in a whole lot of trouble now. . . . we shouldn’t have had all our eggs in one basket.”
While banks like SVB have FDIC insurance, this only insures up to US$250,000 per customer, which isn’t sufficient coverage for most businesses or for high-net-worth individuals. This collapse will therefore make many people reconsider keeping all of their assets in one bank. A customer with US$1 million may consider splitting this total between four different banks.
This is a useful starting point. Beyond diversification among banks, individuals may begin to consider diversifying towards financial institutions in other countries as well as diversifying into other currencies and asset classes, including Bitcoin and other cryptocurrencies.
Part of the appeal of a truly decentralized asset like Bitcoin is that there is no “CEO of Bitcoin” — no management team is making judgment calls on interest rates that could imperil the entire network. As stated above, users don’t have to decide whether to trust a company or management team in order to allocate towards Bitcoin, they can instead verify (directly or by proxy) the open-source code that governs the Bitcoin network. Additionally, anyone can view any transaction ever made on the Bitcoin blockchain, giving the network incredible transparency. Cathie Wood, founder and CIO of Ark Invest, pointed out that the current banking crisis wouldn’t have been possible in “the decentralized, transparent, auditable and overcollateralized crypto asset ecosystem.”
Is Bitcoin one of the winners amidst the current banking turmoil? Many people seem to think so, and they are voting with their wallets. Since the crisis first erupted on March 8, the price of Bitcoin has been surging. While Bitcoin initially briefly fell to under US$20,000 on March 9 amidst the wider market panic, it has since soared to above US$28,000, for a gain of about 40% in just under two weeks at a time when the broader financial market is jittery.
Bitcoin is now up nearly 70% year to date barely a quarter of the way into 2023, surpassing the gains of the S&P 500 and the Nasdaq, which are up 3.8% and 13.8% year to date, respectively. Nik Bhatia and Joe Consorti of the Bitcoin Layer newsletter write that “The [Federal Reserve’s] aggressive rate hikes and balance sheet reduction have caused a historic bank failure — fashioning a real-time ad for bitcoin self-custody.” Market maker Cumberland tweeted that “When traders are unsure about crypto prices, they flee to stables and bank deposits. When they are unsure about stables and bank deposits? It’s crypto’s time to shine, and BTC and ETH rallied 14% and 15% respectively over the weekend amidst uncertainty in the banking sector.”
Beyond the throes of the current crisis, remember that, no matter where someone is keeping their dollars, they are currently losing 8% of their value on an annual basis due to inflation. With a maximum supply of 21 million and a monetary supply that is deflationary over time rather than inflationary, Bitcoin stands out in the current environment where central banks in the United States and around the world are printing more fiat currency than ever before.
Ultimately, the problems of the traditional, centralized financial system led to the Great Financial Crisis and catalyzed the rise of Bitcoin. Fifteen years later, the legacy system is plagued by the exact same problems while Bitcoin has expanded both in value and capability, making it clear that Bitcoin is as necessary now as it has ever been.
