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Could More Bank Failures Trigger the Next Bull Run in Crypto?
What a difference a year makes. 2022 was a monumentally bad year for the crypto industry. Every month seemed to produce a new black swan event more devastating than the last. The collapse of the Terra ecosystem and the contagion that spread across the industry was followed by an avalanche of criticism from legacy banking institutes.
They relished the fact that certain crypto projects were collapsing and causing financial ruin for those foolish enough to invest in them. They would even go so far as to say investors deserved to be wiped out for not fully understanding the counterparty risks associated with crypto.
It is a little ironic then that less than a year later, those same legacy banks started falling like dominoes. All of a sudden, everybody forgot what counterparty risk was.
Why Do Banks Fail?
Before we examine whether these bank failures will kick-start the next crypto bull run, it is important first to understand why these banks failed.
Banks can fail for a number of reasons. However, much of the recent bank failures occurred due to a combination of the following:
- Relaxing Regulations – The Glass-Steagall Act of 1933 separated Banks from mingling commercial and investment funds. Its repeal in 1999 contributed to the 2008 Global Financial Crisis. The Dodd-Frank Act was a response in 2010 to reintroduce regulation to banks holding over $50 billion in deposits. It was reformed in 2018 to raise this new limit to $250 billion.
- Fractional Reserve Banking – Only requires banks to hold a minimum of 10% of all deposits. Banks can take the remaining 90% to invest in “low-risk” yield-generating options like Treasury Bonds.
- Federal Reserve’s Dual Mandate – The Fed has two specific goals it seeks to achieve. Maximize employment and stabilize prices. It achieves this through the printing of new money and the adjustment of Prime Interest Rates.
A Toxic Concoction
When you take these three issues and mix them together, it is only a matter of time before things start to break. Banks holding under $250 billion in assets (which most U.S. regional banks hold) were able to take on more risk. They were the same banks lobbying the government for the increase in threshold from $50 billion under the 2018 reform.
The Treasury Bonds banks bought were marked at a low rate because the Fed had been keeping prime interest rates low. This is key to why the banks started failing.
In 2022 and early 2023 The Fed began aggressively raising interest rates to try and tame inflation. This had a major secondary effect. Borrowing started tightening. It became more difficult to get loans, so accounts started using their savings to cover costs.
Banks operating on with a fractional reserve did not have enough deposits on hand to cover the surge in withdrawals initially. They were forced to sell off their investments to cover the difference, including those medium and long-term treasury bonds from before.
The issue was that those bonds were now worth less than the current market value because the prime interest rates they were attached to had risen. Banks were forced to sell their investments at a loss which, when done over large volumes, created large deficits on their balance sheets. This spurred runs on the banks.
How Does This Help Crypto?
Runs on banks are essentially a crisis in confidence that the bank won’t have enough money to cover withdrawals.
People Are Scared
Once people hear this, it creates panic, and clients rush to pull their funds in a self-fulfilling prophecy. This phenomenon has intensified with the introduction of online banking and users having access to their accounts 24/7.
If people are successful in pulling their funds from a bank before it collapses, they need to decide where they want to re-allocate them to. They have a couple of options:
- Stick it under a pillow – This is obviously a high-risk approach due to security risks and the potential damage physical money could face, not to mention its loss in purchasing power over time due to inflation
- Move it to a bigger bank – There are a handful of banks that hold above the $250 billion deposit threshold. They have more regulations in place and are, therefore, technically more secure. However, they still operate with fractional reserve banking, and centralizing a larger portion of wealth into the hands of a few banks could create another too-big-to-fail event.
- Invest it – If clients chose to invest their money in assets rather than hold it directly in banks, we could see a surge in interest in crypto. However, most people that would take this option would still most likely choose a traditional option like real estate, stocks, or precious metals that are less volatile. In addition, not everyone will be able to choose this option. For example, most of the uninsured deposits caught up in the SVB collapse were from business accounts that rely on that money for payroll and expenses, so investing it is not an option.
People Are Aware
The emperor has no clothes. The recent bank failures shined a light on banking practices for the first time since 2008. Clients who may not have felt the full brunt or been old enough to remember the 2008 crisis received a stark reminder of the risks involved. Where people had no option to opt out of the last crisis, crypto offered a real alternative.
People are tired of how banks operate behind the scenes — self-regulating and lobbying for deregulation to allow them to take on riskier investments. At the same time, when those banks fail, they suffer no repercussions, and taxpayers are used to bail them out.
People are frustrated by their relationship with their banks and are looking for alternatives.
Even if only a small fraction of people make the shift to crypto, the people that do are galvanized and hardened by the process. Every bank failure makes crypto adoption stronger.
