Facing a wave of withdrawals from skittish investors, a crypto-friendly bank is staying solvent thanks to an unusual multibillion-dollar loan — a move Jim Cramer says should knock you off your chair.
“This is extraordinary,” the Mad Money host and crypto skeptic tweeted last week. “A bailout loan from the Federal Home Loan Bank for a crypto bank to stem the run. I wish people knew how dangerous this is all getting. NOT business as usual.”
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The bank run — and the surprising rescue by a quasi-government “home loan” organization — is a sign of yet more instability for crypto investors after a disastrous 2022, which saw the collapse of major exchange FTX and the crypto market’s worst performance since 2018.
If you’re worried that the bell is tolling once more for digital currency, it may be wise to investigate how investors can prepare for a deeper crash.
A ‘crisis of confidence’
Cramer’s outcry comes after Silvergate Capital Corp. — a California-based bank that provides financial services to the digital asset industry — sought a $4.3 billion loan to make it through the “crisis of confidence across the [crypto] ecosystem” late last year.
How bad was the crisis? Silvergate saw total deposits from their digital asset customers plummet from $11.9 billion on Sept. 30 to just $3.8 billion on Dec. 31, company filings show.
“In response to the rapid changes in the digital asset industry during the fourth quarter, we took commensurate steps to ensure that we were maintaining cash liquidity in order to satisfy potential deposit outflows,” explained Silvergate CEO Alan Lane.
Those steps included selling $5.2 billion of debt securities (at a $718 million loss) but also seeking out a mega loan from the Federal Home Loan Bank of San Francisco — a government-sponsored enterprise created during the Great Depression to support mortgage lending and community investment.
Why is the loan so unusual?
The Federal Home Loan Bank (FHLB) system is composed of 11 regional banks that are privately capitalized — that is, they receive no taxpayer assistance — and owned as cooperatives by their members, which include banks, credit unions, insurance companies and community development financial institutions.
The system is regulated by the Federal Housing Finance Agency and provides access to billions of dollars in low-cost funding to members through secured loans.
As reported by American Banker, critics like Cramer argue the FHLB’s loan to crypto-friendly Silvergate is a major departure from its original mission.
“They’re clearly not using this borrowed money for home loans, they’re using it to build up their capital levels,” says Todd Phillips, a policy advocate in Washington and a former attorney at the Federal Deposit Insurance Corp.
“Why is the Federal Home Loan Bank lending them this money? It doesn’t make a lot of sense.”
Last year, the Federal Housing Financing Agency launched its first major review into the FHLB system in 90 years, probing whether it has strayed from its core mission of housing finance. Today, many community banks rely on FHLBs for general liquidity and balance sheet management, even without a direct connection to housing.
While a spokesperson for the FHLB told American Banker that no taxpayer money was used to fund the Silvergate loan, the bailout does shed light on the fragility of the crypto market for investors.
‘I would not touch crypto in a million years’
This is far from the first time Cramer has raised alarm bells over the crypto ecosystem.
After the dramatic collapse of FTX in November, he shared scathing commentary on CNBC on the value of digital assets — and the wisdom of those who own them.
“I sold all my crypto … I would not touch crypto in a million years because I wouldn’t trust the deposit bank,” he said. “If you have your money in [crypto], I’m not calling you an idiot; I’m just saying you have blind faith.”
Multinational investment bank Standard Chartered has cautioned investors that the crypto sector will likely continue to face challenges in early 2023, potentially leading to more liquidity issues and bankruptcies.
Bitcoin prices dropped nearly 65% in 2022, and Standard Chartered said the asset could fall another 70% to around $5,000 in 2023.
How to prepare for a deeper crypto crash
To be sure, the crypto market is famous for its volatility.
Enthusiasts are willing to stay the course because of the enormous growth potential, but for many investors, the dips, dives, ducks and dodges are not worth the stress.
If you think a deeper crypto crash could be coming, here are three ways to manage your risk:
1. The 1% rule
Feeling the burn from the crypto market’s wild swings? The 1% rule can keep your capital losses to a minimum, while still allowing for monthly returns or income.
This strategy, also known as position sizing, is not about the size of your investments but the amount of capital you’re willing to risk. It limits the risk on any given crypto investment or trade to no more than 1% of your total investment capital.
For instance, if you have $20,000 to invest, you could purchase $200 of any given cryptocurrency. If the price of that asset drops to $0, you would only lose a maximum of 1% of your total capital.
2. Stop-loss and take-profit orders
A stop-loss order can limit your losses if your crypto trades turn sour.
Investors can set stop-loss orders to buy or sell crypto assets once they reach a specified price, known as the stop price. This helps to set an exit point in the market and can limit losses.
For example, instead of following the 1% rule, you could purchase $20,000 of any given cryptocurrency, with a stop-loss order to sell at $19,800. That would effectively cut your losses at 1% of your total investment capital.
If you get lucky with your crypto investments, you can also lock in your winnings with a take-profit order — a tool designed to sell an asset once it reaches a certain level of profit.
3. Take control of your assets
The shocking collapse of FTX left many crypto investors unsure if they’d ever see their funds again — highlighting some of the potential pitfalls of keeping crypto with an exchange.
Investors might consider using a non-custodial crypto wallet, where they have complete control over their digital assets and their private data.
At the same time, these wallets also come with risks. They’re not forgiving of errors like lost passwords (also known as “private keys”) or software failures.
This article provides information only and should not be construed as advice. It is provided without a warranty of any kind.