Why this crypto bank is a future cash machine

Capital of Silvergate (NYSE: SI) is a small California bank that has been in existence for over 30 years. In 2013, the bank noticed the rise in interest in cryptocurrencies as Bitcoin (CRYPTO: BTC). The bank wanted to land all new trade like Coinbase (NASDAQ: COIN) as customers and provide banking services to them as well as to all institutions that wanted to trade this new digital currency.

Silvergate therefore created the Silvergate Exchange Network, or SEN, to allow these customers to exchange Bitcoin and other forms of cryptography 24/7. The way it works, institutions that want to trade cryptocurrency open an account at the bank. Then when they trade cryptocurrencies on Coinbase or any of the other Silvergate-aligned trading platforms, that platform manages the crypto exchange while Silvergate transfers the dollars to its client accounts.

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It has been an extremely profitable business for Silvergate, and it is only just beginning. All of these funds are in trading accounts at the bank. And Silvergate pays no interest on deposits. It is therefore a boon for the bank.

Consider for a moment if inflation takes off and interest rates start to rise. The high interest rates are very advantageous for this bank. Since Silvergate does not pay any interest to holders of its trading accounts, it will become more profitable as interest rates rise.

Indeed, the whole rise of cryptocurrency is based on a distrust of fiat money and government debt levels. Crypto in this sense works like gold, as a store of value. In an inflationary environment, the demand for crypto will increase, so it will be a virtuous circle for Silvergate. Dollar inflation will drive demand for alternative investments like crypto. More and more institutions will deposit cash at Silvergate in order to purchase cryptocurrencies. Meanwhile, as interest rates rise to fight inflation, Silvergate is making more and more money through its interest-free accounts.

Silvergate is very profitable even when interest rates are low

Right now, we are in a very low interest rate environment. And Silvergate is doing very well with its 33% profit margins. The bank has nearly $ 4 billion in net cash. But it’s sobering to think that if inflation starts to rise, this bank will do much better.

Despite low inflation right now, people are buying cryptocurrencies, not as a hedge, but with the belief that these currencies will be more valuable in the future. Silvergate has seen spectacular growth in its deposit base and number of transactions in recent months. As CEO Alan Lane reported on the Q1 2021 conference call, “In Q1, activity on SEN continued to grow at an all-time high with nearly 167,000 transactions and over $ 166 billion. SEN volume dollars, up 84% on a basis. “

This current demand for crypto can be attributed to the large companies backing the currency in the fall. Square (NYSE: SQ) announced in October 2020 that it was buying $ 50 million worth of Bitcoin. And recently he bought an additional $ 170 million. PayPal funds (NASDAQ: PYPL) has also jumped into the crypto space in a major way.

These moves have increased demand for Bitcoin, and Silvergate is seeing an influx of money. “Average digital currency customer deposits grew by $ 3.8 billion to $ 6.4 billion, from an average of $ 2.6 billion in the fourth quarter of 2020,” Lane said.

Unsurprisingly, the stock rose as demand for the bank’s services skyrocketed.

SI chart

IF given by YCharts

Silvergate is just getting started

What’s remarkable about Silvergate is how small it is compared to these other crypto players. Square has a market cap of $ 111 billion. PayPal is a $ 311 billion giant. Even Coinbase is a big company, with a valuation of $ 58 billion. Silvergate is a small bank with a market capitalization of $ 3 billion. So this is very early days, and there is a lot of room for this stock to skyrocket.

What will really be a cash cow for the bank is the SEN leverage. As Lane said on the conference call, “Last year we launched our secured loan product called SEN Leverage, whereby institutional investors receive funding in US dollars by entering into a loan agreement with Silvergate.” .

Banks make money by lending money. The money Silvergate has earned on SEN so far is small potatoes compared to this new loan program. In the first quarter, Silvergate announced partnerships with Coinbase and Fidelity to act as digital custodians. These larger financial partners, and others like them, will store digital currencies. And Silvergate will make loans using those assets as collateral.

As Benjamin Reynolds, Chief Strategy Officer of Silvergate, noted on the conference call, “We don’t know of any significant new competitor willing to provide Bitcoin-backed US dollar funding.” This is a new opportunity for the bank.

Silvergate recorded astonishing numbers in the first quarter, with deposits more than doubling from the fourth quarter of 2020. The bank has billions in its trading accounts. But the real money will be earned when Silvergate starts lending to its institutional clients and collecting interest. This is the future of this crypto bank. And it will be very lucrative.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.