Silvergate Capital Corp. (SI) is the country’s first-ever and largest dedicated crypto bank, a $13 billion institution currently serving the highest number of crypto customers in the US; the key to its success is a real-time payments exchange platform, notes Adam Johnson, growth stock specialist and editor of Bullseye Brief.

Silvergate is the only bank I have ever encountered which does not pay interest on deposits. This is because clients deposit cash for the purpose of being able to fund crypto transactions instantaneously 24/7, rather expecting a traditional cash management relationship.

To maximize flexibility and best serve clients, Silvergate holds a 30% cash position at all times, and invests another 50% in highly liquid agency-backed mortgage securities and municipal bonds. The remaining 20% of deposits fund loans backed by borrowers’ crypto holdings.

Its Silvergate Exchange Network enables real-time transfer and settlement of US dollars 24/7 between institutional investors and digital currency exchanges in order to fund cryptocurrency transactions.

The network includes the world’s five largest crypto exchanges and the 1,300 largest institutional traders of cryptocurrency. Silvergate does not charge fees for USD/BTC exchange, but instead earns interest on all currency held for clients.

The fastest growing part of Silvergate’s loan portfolio provides loans collateralized by bitcoin, with additional coins being added to the program monthly. Loan leverage is capped at 50-65% of the value of a client’s crypto holdings, providing ample cushion against volatility and mitigating risk to Silvergate’s balance sheet.

Customers have tripled since 2018, and their collective deposits have risen ten-fold to $11.8 billion. Higher volumes have propelled earnings over 200%  higher during the period, and are on track to reach $2.91/share in 2021. Consensus estimates among the 9 analysts covering Silvergate call for earnings of $3.80 this year and over $6 next year.

If JPMorgan is correct in estimating that only 10% of institutional investors currently trade crypto, Silvergate could see its volumes rises significantly over the next several years.

The company has just announced plans to buy the Diem crypto platform from Meta Platforms (FB) — formerly Facebook — for $200 million. The bank has not announced its intentions for Diem, but Diem’s value was estimated last year at $3 billion. Silvergate — as the premier crypto-first bank — will do something exciting with Diem. It also has enough cash to purchase Diem outright.

I think there are several potential risks to my thesis:

  1. The crypto market fails to catch on among a broader group of institutional investors.
  2. Regulators squelch nascent growth by erecting barriers to the free flow of capital.
  3. Rates rise more than expected, causing a contraction in forward valuation multiples.
  4. Customers demand interest on their deposits, especially as rates rise.
  5. Deep-pocked competitors create alternative exchange networks, rivaling Silvergate’s monopoly.

Here’s my logic: If the company can grow earnings an average of 40% over each of the next three years… reflecting JPMorgan’s estimate that only 10% of institutional investors currently participate in the crypto market… applying a slightly scaled back P/E multiple of 35x yields a 2025 target of $280. This is more than double the current stock price.

I like owning Silvergate under $140. I recognize that current volatility could knock it to $100 on any given week, so I will go gently. I’ll buy a one-third position initially, and save ammo for any potential declines. My $75 alert is well below the current price to reflect market conditions. This is a volatile stock in a volatile sector in a volatile market.

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