CRYPTO’S most ardent supporters present it as the future alternative to regular money. What they sometimes fail to mention is that, for now, most digital currencies still rely on old-fashioned banks for their existence. The need for “on and off ramps” for converting crypto into traditional currencies and back, and the risks this creates, were on display in March when two crypto-friendly US banks collapsed. And a major stablecoin briefly lost its peg to the US dollar after its reserves were stuck at a failed bank. The collapses make it harder for investors to funnel cash into digital assets, and raise a question: Is mainstream banking’s brief affair with unconventional finance already over?

1. What are “on-ramps” and “off-ramps”?

An on-ramp is somewhere you can exchange regular currencies such as US dollars or euros for cryptocurrencies such as Bitcoin or Ether. Off-ramps let you swap crypto assets for traditional money. This mostly happens on crypto exchanges such as Coinbase and Kraken as they can accept money through bank transfers or credit card payments. It’s possible to trade crypto tokens “peer to peer”, without using a regular bank, but as very few products or services can be bought with digital currency, investors usually need to off-ramp before the proceeds can be spent.

2. Where do banks come in?

Crypto exchanges such as Coinbase, Gemini and Kraken have been able to function as gateways between real and digital money because of their partnerships with banks such as Silvergate Capital and Signature Bank. The exchanges relied on services like the Silvergate Exchange Network and Signature’s Signet to allow crypto clients to make real-time payments in dollars at any time, seven days a week, matching crypto’s own 24/7 trading hours.

3. Why did those banks collapse?

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A confluence of misfortunes felled Silvergate, Signature Bank and another tech-focused lender, Silicon Valley Bank (SVB), not least the end of rock-bottom interest rates. Crypto volatility also played a part:

• Silvergate invested a chunk of crypto-related deposits in mortgage-backed securities and bonds sold by state and local governments whose value slumped as benchmark rates rose. When crypto markets tumbled in 2022 and exchanges such as FTX hit the wall, clients rushed to withdraw money. Silvergate had to sell securities to honour those withdrawals, losing more than US$1 billion along the way and hastening its demise.

• Signature began to pull back from digital assets after the FTX blowup but still had US$16.5 billion in crypto-related client deposits as of Mar 8. That appears to have unnerved depositors already shaken by SVB’s demise, leading to a run on deposits.

• SVB’s failure was attributed largely to its exposure to slumping tech startup valuations and some unwise bond investments. It was also a useful partner for one prominent crypto firm: US stablecoin operator Circle said it had US$3.3 billion of USD Coin reserves deposited at the bank.

4. What does it all mean for crypto regulation?

Banking regulators have long taken a dim view of crypto. Its volatility makes it a potential source of unsustainable losses for investors and instability for the wider financial system. Critics say it can be used by bad actors to shift around their ill-gotten gains free from the checks and oversight required of regular banks. And it’s hard to verify the value of reserves that can serve as collateral when a crypto asset or institution suffers a crisis of confidence. Regulators are now looking to fix the weak links in the US banking system revealed by Silvergate, Signature and SVB, and one of those is the exposure of smaller lenders to volatile crypto assets. It marks a turnaround for a government that, until recently, had sought a lighter-touch approach for smaller banks, to allow them to innovate in areas like digital assets.

5. What is the government doing about it?

The first target for official action was Silvergate. US prosecutors in the Justice Department’s fraud unit were looking into the bank’s dealings with FTX and its trading firm Alameda Research. The criminal investigation was examining accounts that Silvergate hosted for FTX co-founder Sam Bankman-Fried’s businesses. The probe touches on what banks and intermediaries working with Bankman-Fried’s firms may have known about what officials have called a scheme to defraud investors and customers. The bank hasn’t been accused of any wrongdoing, and the investigation could end without charges being filed.

6. Could the bank failures sink crypto?

Even if regulators don’t ban US banks from handling digital tokens, the crypto world is likely to face costly, lengthy contortions to move funds to and from US banks, which is likely to slow down settlements. A similar scenario played out in India in early 2022. Trading volume fell after several crypto exchanges had to suspend rupee deposits because banks and payment gateways pulled support for money transfers. With US regulators apparently determined to slash banks’ exposure to crypto, many crypto firms began searching for alternative banking partners in places such as Switzerland and the United Arab Emirates. US investment in crypto may also suffer. Until recently, many of the country’s banks were experimenting with crypto and related blockchain technology, suggesting the new asset class may eventually go mainstream. That’s less certain now. BLOOMBERG