Deep-dive: The collapse of banks and the consequences for crypto

The US government raised interest rates sharply in the past year. With an interest rate of practically 0%, it rose to an intended target of 4.50 to 4.75%.

The high interest rates ultimately led to the collapse of Silicon Valley Bank (SVB) and two other smaller banks. The collapse of SVB, America’s 18th largest bank, may be a win for Bitcoin (BTC). Perhaps the US will cut interest rates in response. If so, it can ensure that investors will gradually re-enter the crypto market. In this deep dive we take a look at what exactly happened to the banks in America and what this means for Bitcoin and the crypto market.

How did the banks collapse?

Many tech companies used SVB as their bank. These mostly successful businesses led to an influx of deposits. The California bank invested a large portion of this in long-dated US government bonds, including bonds backed by mortgages. At the time, these bonds seemed to be a safe investment in all respects, according to the bank. This is also usually the case, at least as long as interest rates do not rise.

Bonds have an inverse relationship with interest rates. That is, when interest rates rise, bond prices fall. As a result of interest rate hikes by the Federal Reserve (FED) to combat inflation, SVB’s bond portfolio began to decline significantly in value. This need not be a problem if you can serve the full term of the bond. Then you get all your capital back.

The problem was with SVB that they could not sit out that period. As economic conditions deteriorated over the past year, with technology companies particularly affected, many of the bank’s clients began withdrawing their deposits, reducing the amount of money available at the bank.

As a result of both the fall in the price of US government bonds and poor economic conditions for tech companies that massively withdraw cash from the bank, SVB eventually ran out of cash. The rest of their clients’ money was mostly in government bonds. To get that money available, the bank had to sell part of its bonds early with huge losses, which scared investors and customers.

Customers panic

Banks hold only part of their assets in cash. This usually works out because customers leave their money in the bank. By investing part of it, banks can now earn more money with those deposits. This generally goes well, but they are susceptible when a large demand for cash arises from their customers. While SVB’s troubles stem from earlier investment decisions, customer panic began to set in on March 8, when the bank announced a $1.75 billion capital raise. The bank told investors it needed to close a gap created by bond sales.

Customers were now aware of the deep financial problems at SVB and began to withdraw money en masse. Unlike a private bank that focuses on businesses and households, SVB’s customers generally had much larger accounts. This meant that the bank run happened relatively quickly. Two days after the bank announced it would raise capital, the $200 billion company collapsed, the largest U.S. bank failure since the global financial crisis in 2008.

Consequences for Bitcoin?

If we dive into a piece of history, we see that Bitcoin has experienced a banking crisis more than once in its history. The cryptocurrency itself was developed as a criticism of the banking system in America and the resulting crisis in 2008, saw a sharp increase in price during the banking crisis in Cyprus in March 2013. The cryptocurrency rose that month by 178% and hit an all-time high of $265 in May 2013. It was rumored that euro holders were diversifying into Bitcoin to spread their risk in the event of an ongoing banking crisis.

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