Signs of Trouble at Signature Bank
Banking crypto comes with risks. New revelations suggest legal and regulatory problems loom for $SBNY.
Note: For the first time in our brief journalistic career, we are short the subject of the following article.* What follows is not investment advice and for informational purposes only.
The crypto-friendly Silvergate Bank (SI) has had a rough couple of months. Ever since it was revealed that Silvergate was doing a lot of business with the now-disgraced crypto mogul Sam Bankman-Fried, investors and customers have grown wary of certain heretofore unappreciated risks of working with cryptocurrency businesses. Silvergate shed 68% of their total deposits, some $8.1 billion, in this quarter according to preliminary reports. Their need for cash forced them to sell debt instruments early, reportedly leading to a loss of some $718 million.
Silvergate’s financial woes are matched by its legal concerns. It was discovered that Silvergate was allowing Alameda Research to receive customer deposits that were supposed to be going to the FTX exchange. In addition to new attention from regulators, Silvergate faces a class action lawsuit from FTX victims alleging that the bank was complicit in the FTX fraud.
While Silvergate has received most of the public wrath for its role in this fraud, another crypto-friendly bank has avoided much attention from the media: Signature Bank of New York (SBNY). Silvergate and Signature have unique relationships with the cryptocurrency industry. Both companies created their own private blockchains, the Silvergate Exchange Network (SEN) vs. SBNY’s Signet, to service their crypto clients by providing 24/7/365 dollar transfer services. These services have been wildly popular, with each firm performing hundreds of billions of dollars in transaction volume each quarter:
Both banks provide depository services for crypto exchanges, funds, and stablecoins. Signature is one of the major holders for the deposits backing the major stablecoin USDC as well as banking dozens of other major crypto firms.
Signature has downplayed its exposure to the collapse of FTX by specifying that they never made loans to the defunct exchange, only that they had a “deposit relationship.” They have also announced they are going to try and sell off up to $10 billion of their crypto related deposits. This announcement seems to have anticipated a joint warning from the FIDC, OCC, and Federal Reserve about banking for crypto companies.
The lack of attention on Signature may be about to change. Signature faces significant and obvious risks from holding large deposits for crypto entities at risk of sudden and massive withdrawal pressures. As seen with SI’s preliminary Q4 results, these withdrawal pressures can be severe and lead to massive losses for the bank when it needs to come up with the money. However, crypto bank runs are not the only risk Signature faces in the coming months. According to recent revelations, Signature may face significant legal and regulatory consequences from doing business in the fast and loose world of cryptocurrency.
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Signature’s Signet blockchain: A “walled garden” full of snakes…
Signet is Signature’s own private blockchain. “Signets” on this blockchain are tokens representing dollars, very similar to stablecoins on public blockchains like Ethereum. Signture’s approved Signet customers can use this blockchain to make instant dollar transfers to other Signet clients 24 hours a day, 7 days a week. Signet has become a very popular alternative to Silvergate’s SEN system.
In 2021, the chairman and co-founder of Signature Bank sat down with “The Asian Banker” for an extended interview about Signature’s crypto adventures. This interview is fascinating and worth watching in its entirety. Mr. Shay states he was interested in cryptocurrency relatively early and was seeking to find ways to bank with crypto firms for years before they developed Signet. In this interview, Mr. Shay refers to SIGNET as a “walled garden:”
SHAY: We built what I like to call a “walled garden.” If you pass through this walled garden and you’re a miner, you’re an exchange, you’re a custodian… if you get through our vetting process— we have a strenuous KYC/AML process because we are an American onshore bank— then you’re going to get into this walled gated community and you’re going to get access to Signet. And Signet is a blockchain-enabled tool that you can use with other people who are part of this community so you know they have been vetted…
Shay places a lot of faith in this vetting process. There’s an interesting point where the interviewer asks a prescient question:
INTERVIEWER: Do you ever lose sleep that there might be a Mt. Gox there somewhere in that pool of clients… the regulators will come after you…?
SHAY: Here’s the thing. We’re not touching the crypto itself and we’re not the custodian for the crypto. We’re facilitating the payments…. But I wanted to go back to what I was saying at the very beginning. We take a minority of the accounts that apply to us because we go through a vetting process that is substantial so to get into the gated community does require you to have certain financial wherewithal and to be a solid citizen.
Despite this strict vetting, the above Motley Fool analysis suggests Signet had over 1000 customers by Q4 2021. According to the interview with Shay in June 2021 Signet had at least 740 crypto customers:
INTERVIEWER: You have about 740 digital currency exchanges as customers? Is that about right?
SHAY: Yes, we’re growing about as fast as we can do it on Signet.
Basically, once you get past the initial “due diligence” and KYC, you’re considered clean and free to do as you like. Transactions hosted by the Signet blockchain are peer-to-peer with, apparently, minimal oversight.
While Shay compares Signet to a walled garden, here’s a better analogy: It’s like a basement nightclub. Once you get past the bouncer outside, you can party however you like. The drinks are free, the ceilings are mirrored, all your friends are there, and the best part is: No one is watching.
What could go wrong?
Well, it turns out that Shay‘s walled garden ended up infested with snakes. FTX’s bankruptcy filings, we see that multiple FTX shell corporations had banking relationships with Signature. Notably, Alameda Research passed Signet’s stringent door check:
And, the main FTX exchange integrated Signet services in October 2021:
It’s interesting to note that this legal filing lists Alameda as holding a Signet account, while the other shell companies do not. FTX advertised being integrated with Signet. It seems possible that, like Silvergate, Signature was enabling dollars intended for FTX to flow to Alameda through its private blockchain.
Signature has collaborated with other questionable projects. One example is the stablecoin TUSD (True USD). A relatively small stablecoin by market cap, TUSD has close ties to both Alameda Research and an infamous character named Justin Sun. Justin Sun’s notable characteristics include his frequent harrowing experiences at the hands of law enforcement and his habit of collecting bank accounts like baseball cards.
As shown by the excellent DataFinnovation, a large portion of TUSD “burn” volume (aka, redeeming the stablecoins for real dollars) was performed by just two entities: Alameda Research and Justin Sun. It’s interesting to note that another big user of TUSD was the infamous “sifu,” a convicted scammer with close ties to the QuadrigaCX exchange fraud
Now, consider the hundreds of billions of dollars in transactions hosted on the Signet blockchain and who was using that blockchain. We have to believe that regulators will take an interest in this product. Indeed, according to the press release announcing that New York state regulators had approved the creation of Signet, one of the stipulations was that Signature:
Implement,monitor and update effective risk-based controls to prevent and respond to any potential or actual wrongful use of virtual currency, including but not limited to its use in illegal activity, market manipulation, or other similar misconduct, as required by DFS’s February 7, 2018, “Guidance on Prevention of Market Manipulation and Other Wrongful Activity”
Signature may have enabled USD transfers to Binance through a defunct Seychelles shell company
Recent work by Deltec’d, a researcher whose previous work has exposed details about Tether’s banking relationships, discovered interesting ties between Binance, Silvergate Bank, Signature Bank, and a Seychelles shell corporation. Between December 2020 to May 2021, Binance used Silvergate to process USD transfers from customers. Notably, when a customer sent dollars to Binance, the name on the recipient account was not Binance. Instead, the account was registered to “Key Vision Development Limited,” a Seychelles-registered shell company. In May 2021, Silvergate apparently bowed to regulatory pressure when it suddenly severed ties with Binance. By September 2021, the heat was so intense that Key Vision Development, along with a company called “Binance Investments Co., LTD.” were struck from the Seychelles register of companies.
Deltec’d discovered that Binance may have continued to use Key Vision Development as a front company. However, in place of Silvergate it appears that Signature Bank may have become Binance’s new favorite bank. Deltec’d found two independently-created YouTube tutorials from January and June of 2022 that provided instructions for depositing dollars to Binance. In both instances, the videos included screenshots from the transfer page that showed Signature Bank listed as the recipient bank, with Key Vision Development as the beneficiary:
As noted by Deltec’d:
This is either negligence at best, or worse, intentional blindness on the part of Signature Bank, as news surrounding the phony Binance shell company “Key Vision Development Limited” has been in the public domain since at least June of 2021. Keisha Hutchinson is the Chief Risk Officer of Signature Bank. The Office of the Comptroller of the Currency (OCC) is the bank’s main regulator.
Of course, it is possible that two independent YouTube video creators separately forged this information six months apart for some reason. We can’t fathom why this might be, but maybe we should give Signature the benefit of the doubt.
We think they will be needing it.
* We were short SBNY since mid-2022 via far OTM puts. We closed that position late last year for a profit and have now opened a new position. Again, do not construe anything in this article as investment advice!
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A walled garden private blockchain seems like a great conduit for "exchange coordination" business as well...