Short Sellers May Have Contributed To Silvergate's Collapse.

After a gradual decline, Silvergate Capital SI +2.85% stock reacted suddenly, resulting in a sizable payday to bearish traders who had bet against the crypto-focused bank in the first place. There may also be some responsibility on the part of these short sellers for what happened.

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The Silvergate Bank (ticker: SI), once a leading provider of financial services to the digital asset sector, announced on Wednesday that the bank would be voluntarily winding down its operations and filing for bankruptcy. There was a 37% drop in the stock between Tuesday and Thursday, but that was only the latest leg downward for the shares, which had already gone down 90% since early November when the bankruptcy of crypto exchange FTX rocked the crypto market.

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During the gradual implosion of Silvergate, traders who shorted the company knew they were going to make a lot of profits from the fall in its share price, as they bet against it and bet the price will fall. This trade involves borrowing shares of a company, then selling them at a lower price, with the expectation that the stock will be able to be repurchased at a later date for a lower price. It's the ultimate bet in the bearish direction.

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Prior to the announcement that Silvergate would wind down, shorting Silvergate stock was one of the most active trades on Wall Street in late February, just before the bank revealed it was evaluating its ability to continue operating. S3 Partners, a data analytics firm, reports that close to 90% of the company's shares have been lent out for short selling, making it the most heavily shorted U.S. stock, based on short interest, which is how many shares have been sold short, with at least $10 million in short interest.

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A share of Silvergate stock opened just north of $3 on Thursday, after beginning November above $55. The number of shares sold short over that period skyrocketed by 624%, resulting in a profit of $492 million for short sellers on a mark-to-market basis, according to Ihor Dusaniwsky, a managing partner at S3, as the number of shares was sold short.

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“The short sellers have been active in building their positions in Silvergate stock in recent months, which has been a very profitable trading strategy as Silvergate's stock price has declined significantly," says Dusaniwsky. “The short side must now decide whether to trim or close out their Silvergate exposure with buy-to-covers in order to realize the mark-to-market profits they've earned so far or to hold on to their positions and squeeze out the remaining Alpha in the trade."

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Possibly the biggest factor behind Silvergate's troubles may have been short sellers, who proved to be one of the driving forces. In line with much of the rest of the digital asset sector, the stock price of the bank had already been under pressure as early as November, following a high near $220 in late-2021 amid cascading BitcoinBTCUSD -1.71% prices and an upsurge in bankruptcies in the sector.

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Silvergate's stock dropped sharply after FTX, one of its customers, declared bankruptcy on Nov. 11. As a result of FTX's failure, Silvergate, one of the few banks that deal with crypto companies, came under intense regulatory scrutiny, leading to a crisis of confidence across the digital asset industry.

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In the end, Silvergate Bank's collapse came about as a result of huge losses on asset sales that took place at the end of last year as the bank divested assets at fire sale prices in an attempt to remain liquid in the face of a bank run at that time. It is believed that short sellers accelerated the run on the bank, according to analysts at J.P. Morgan.

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“It has been a period of back and forth over the past several months between short sellers of Silvergate stock and the company responding publicly multiple times to short sellers' requests to maintain trust in its ecosystem,” according to a team led by Steven Alexopoulos in a note earlier this month. “It appears that short sellers have contributed to a bank run by short selling.”

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Typically, bank runs are associated with concerns about credit quality, according to J.P. Morgan analysts. As for Silvergate, the analysts believe the run was sparked by a combination of events, including the erosion of trust across crypto after FTX's meltdown, as well as the voicing of concerns by short sellers, mainly on Twitter, as well as the deteriorating trust in crypto.

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While the bearish traders were fueling the fire that burned Silvergate stock and its investors, they were also earning a big payday for themselves at the same time. The reason for this is not to downplay the fact that the bank was faced with problems that were completely out of its control. Nevertheless, the collapse of Silvergate shouldn't be the only reason for soul-searching among those involved in a high-risk industry following this company's demise.