Could A Run on Banks This Week Affect Crypto? 

TLDR: A run on TradFi banks this week might spread to centralized crypto exchanges, however strong assets like BTC and ETH might handle the worst of the resulting volatility better than most assets. 

What is a Bank Run? 

By now most people are aware of what happened at Silicon Valley Bank (SVB) and how the FDIC has stepped in. What’s yet to be determined as I write this on Sunday morning is how the contagion will (or won’t) spread. 

Financial institutions may face a critical situation when a large number of depositors make withdrawals within a short period of time, causing a bank run. This typically happens because the withdrawals exceed the institution’s available funds, even though it may have sufficient resources to fulfill its obligations. 

For physical banks, the amount of cash that can be stored at each location is limited by cash limits set by the U.S. Federal Reserve, based on typical demand to mitigate risks. Banks also use a fractional banking system to lend or invest a significant portion of customer deposits, while keeping some funds on hand to cover withdrawals and protect consumers. However, during a bank run, banks may need to sell assets quickly to avoid insolvency, and may rely on central bank loans as a last resort. 

For cryptocurrency exchanges, bank runs can be especially harmful, as they may handle billions of dollars in transactions and may use custodians to handle transfers, which may not have the same requirements for customer protection. This may lead to potential issues when investors try to withdraw all their funds within a short time frame.

Think “Bailey Building and Loan” from the movie “It’s a Wonderful Life.” 

What Causes Bank Runs? 

Fear of loss, pure and simple. Bank runs historically were not caused by a few individuals withdrawing their funds due to risky investments, but instead were responses to external political or economic factors. The 1929 stock market crash, for example, led to widespread panic and caused many Americans to seek physical cash. Rumors of banks running out of cash reserves triggered some of the earliest bank runs.

Today, most bank runs occur silently, with people withdrawing funds digitally rather than forming long lines outside local banks. In the event of a potential bank failure, strict procedures are in place to prevent it, such as receiving funds from central banks or allowing another bank to take over seamlessly.

Regardless of the form it takes, bank runs are usually swift and unexpected. However, crypto exchange runs may have a few warning signs that indicate the exchange is in trouble.

What Happens to Asset Prices?

If we do see even a “threat” of a bank run, no asset is safe from price distribution. I’ve seen this through every bear market for the past twenty years, that everything gets thrown out the kitchen window when prices start to plummet. That includes bonds, precious metals, stocks, crypto, real estate, you name it. There truly is no safe harbor when one of these monsters gets moving. 

The reason for this is margin calls and forced redemptions; investors have to raise cash immediately to handle margin calls and they will sell the most liquid assets on hand just to meet obligations. 

But then something miraculous happens; assets that are on sale and desirable get immediately bid up. For example, if we see a quick price drop on BTC below $20k due to uncertainty and bank runs, be patient and look for a bottom soon. Assets will start to be bid up when few have the courage (and the level head) to take the “smart money” risks.