Ken Griffin, the CEO of the massive hedge fund and market maker Citadel Securities, has an estimated net worth of $33 billion, so he's definitely had some success when it comes to investing.
That's why it was pretty interesting to see that Citadel recently disclosed a 5.5% stake in the crypto bank Silvergate Capital (SI 11.11%), which is one of the most shorted stocks in the U.S., with more than 72% of its shares being sold short. Let's take a look at the situation that Silvergate has found itself in and what Citadel may be up to.
How Silvergate got here
A company does not simply become the most shorted stock in the U.S. Normally it happens when the stock becomes extremely overvalued or there is a problem with the company's business model. In this case, Silvergate's business model ran into huge issues, particularly in the back half of 2022.
Image source: Getty Images.
The bank caters to the crypto industry with its real-time payments network that enables crypto traders and crypto exchanges to transfer U.S. dollars or euros between one another in real time around the clock. This is key in facilitating crypto trading because cryptocurrencies trade around the clock.
The payments network brought lots of clients to Silvergate, which also brought large sums of non-interest-bearing deposits to the bank. This essentially served as a free source of deposits, which Silvergate could invest in interest-earning assets and make money on the spread. So, the key to Silvergate's business was the deposits.
But then the FTX debacle happened. Silvergate serves almost every major crypto exchange, and FTX was a pretty big client, making up about 10% of Silvergate's deposits. This caused a crisis of confidence in the industry, and suddenly long-time clients of Silvergate were pulling their deposits in droves, essentially amounting to a bank run. Silvergate saw close to 70% of its deposits leave the bank in the fourth quarter of 2022.
Silvergate doesn't take on a lot of credit exposure and maintains a liquid balance sheet, but it had a lot of its excess liquidity invested in bonds, and many of these bonds were trading at losses due to the high-interest-rate environment. Silvergate had to sell bonds while they were trading at a loss to cover the deposit outflows and ended up destroying a lot of their equity in the process.
Despite the stock being down considerably, many investors believe the bank could potentially be looking at hefty regulatory fines and legal trouble due to its connection with FTX. The argument is that Silvergate likely violated some kind of anti-money laundering, Bank Secrecy Act, or Know-Your-Customer laws in its dealings with FTX. This could be enough to put the bank out of business or send the stock to zero, the shorts argue.
Silvergate has faced scrutiny from lawmakers, and media outlets have already reported that the U.S. Justice Department is investigating Silvergate's connection to FTX, although the bank has not been formally accused.
What Griffin might be thinking
If Silvergate does avoid overly punitive regulatory actions, then the stock would likely be a decent investment going forward because it provides critical infrastructure to the crypto industry. If crypto rebounds, Silvergate would likely benefit.
But it doesn't look like Citadel is necessarily taking a true long position. An anonymous source told CoinDesk that Citadel is more interested in purchasing shares as a market maker and using them to sell various options on Silvergate. There's been a ton of volatility on Silvergate options, and market makers can make good spreads on options, so it's quite possible Citadel has no interest in going long on Silvergate and rather sees a great opportunity in the options market.
That said, other funds such as BlackRock and Susquehanna have taken positions in Silvergate. Ultimately, the future remains very uncertain for Silvergate until it can remove the regulatory overhang, so this is a very risky stock right now.
