Crypto, Startups and Banking Make a Scary Mix

Mint

14 hours ago

(Bloomberg Opinion) -- The next must-have accessory for crypto and tech bros looks to be far less sexy than a Lamborghini — it's a banking license. Getting approved is typically time-consuming, bureaucratic and dull, but these budding lenders are likely to find themselves pushing on an open door — and that poses dangers.
Stablecoin issuer Circle Internet Group Inc. and tech billionaire Peter Thiel are among the names linked with trust bank charter applications in recent days. The backdrop to this is a White House pushing for regulators to help innovation and growth in the economy and finance. Some of that is down to the backing Donald Trump got from Silicon Valley billionaires and crypto moguls in last year's presidential race, plus his personal financial interests in memecoins and digital assets.
But it is also down to frustrations with a long drought in new bank formations since the financial crisis of 2008. Before that, many years had seen 100-200 new banks each, according to the Federal Deposit Insurance Corp. Since then, most years have barely seen 10 or 15 lenders open for business. Ultra-low rates have made simple banking less profitable, but campaigners for small banks also blame heavy-handed regulation and tough capital rules.
Michelle Bowman, the Trump-appointed chief regulator at the Federal Reserve, has spoken often about this dearth in new banks and promised to bring back more tailoring of supervision and regulation to make life easier for small banks.
Stoking the system with banks heavily linked to venture capital and crypto could be a terrible idea, however. These two industries were at the heart of the mini-banking crisis in spring 2023 — and not by coincidence. 'These are the most macroeconomically sensitive parts of the economy,' Steven Kelly, associate director of research at Yale School of Management's Program on Financial Stability, told me. 'When interest rates go up, they are the first sectors to turn down.'
Ripple Labs Inc. and BitGo Inc. have recently begun trust bank charter applications, according to Bloomberg News, following the lead of stablecoin issuer Circle, which started its bid to become a bank hot on the heels of its $8 billion initial public offering last month. These national charters don't allow banks to collect deposits or make loans directly, but they can use technology and correspondent banking partners to accomplish the same services. Only one crypto company has gained this kind of national license previously, Anchorage Digital Bank in 2021. But other lenders have become deeply entwined with the industry: The best known, Silvergate Bank and Signature Bank, both failed in March 2023.
Another hopeful is Erebor, a digital bank startup backed by an all-star cast of JRR Tolkien fans, including Thiel and Palmer Luckey, according to several reports last week. Their bank, named for a dragon's mountain home in The Lord of the Rings, will focus on the 'innovation economy' including tech businesses and digital currencies. It aims to fill a gap in the market left by the failure of Silicon Valley Bank.
The 2023 crisis was concentrated around the West Coast tech scene similar to the way Texas suffered a wave of bank failures in the 1980s, as I wrote at the time. The boom and bust of a dominant local industry (oil in the Texas case) caused irreparable harm to the banks most exposed to it. With Silvergate and Signature (the New York-based exception to the West Coast rule), the problem was that a dominant share of their deposits was there only as a gateway to crypto markets: When prices tumbled and trading dried up, the money left, ruining the banks.
At SVB, its funding was mainly cash raised by startup companies. When rising interest rates hit valuations and froze venture capital fundraising, the bank's funds began to shrink too. Startup cash burn became SVB's deposit burn, exposing cracks in its business months before the faster run that killed it off.
These banks were focused on economically sensitive industries that are highly correlated to each other, and they lacked diversification of funding. That's a bad business model and it is much more significant in explaining the 2023 failures than depositor fears about unrealized losses on bonds, or the role of social media in transmitting panic, according to Kelly and Jonathan Rose, a senior economist at the Fed Bank of Chicago, in a paper(1) they co-authored on the 2023 blowups.
Circle, Erebor and the rest look like they're running straight back toward this bad business model trap. The more successful they are and the bigger they grow, the more dangerous they could be. It's worth remembering that Silvergate and Signature were still small when they created fears of a rolling disaster.
As Bowman has discussed in several speeches, the tailoring of bank rules isn't just about size but also complexity and business models. The last of these is what should be ringing alarm bells over these wannabe bankers. The last thing the US needs is a whole new group of banks with a hyper focus on stablecoins, crypto and startups.
More From Bloomberg Opinion:
(1) Rushing to Judgment and the Banking Crisis of 2023. Steven Kelly and Jonathan Rose. Working paper for the Federal Reserve Bank of Chicago, March 2025
This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.
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