In this podcast episode, Lorraine discusses the recent failure of Silicon Valley Bank (SVB) and its impact on the price of stable coins, particularly USDC. She summarizes why USDC lost its dollar peg, what this depegging laid bare, and what it means for crypto users, stable coin issuers, and crypto adopters. She concludes that there is a need for more robust stable coins, and it is incumbent upon stable coin issuers to stress test their innovations and protect their holders
Episode Highlights
Stable coins were created to provide stability to crypto assets by being pegged to a stable asset like the US dollar.
Stable coins are integral to the crypto space, and transactions involving them accounted for $1 trillion in 2022.
The failure of SVB caused the value of USDC, the second largest stable coin, to drop to $0.82 on certain protocols, as $ 3 billion of Circle's cash reserves were held by SVB, and only $250,000 was insured. This led to panic among USDC holders, which led to USDC’s drop in value.
Stable coins are subject to the vagaries of human nature and counterparty risks, and their success is dependent on the confidence people have in them.
There is a need for more robust stable coins, because their usage and adoption is based on their perceived stability.
Additional reading
Fiat-backed stable coins
Stable coin usage and adoption
Crypto-specific news websites
Whenever I talk to my friends about crypto, they bemoan the volatility of crypto prices. This volatility was on display early last month when SVB failed. Bitcoin, which was worth $22,000 prior to March 9th plunged to $19,600 after SVB failed on March 10. Then, 12 days later, it was worth $28,500. I usually tell my friends to zoom out and look at the bigger picture, and that volatility, sometimes extreme volatility, has been an attribute of this space since Bitcoin was under $100. The volatility of crypto prices was what inspired, in part, the development of stable coins. Those that are US-dollar pegged, such as USDC, the second largest in the space, have a value of approximately $1, and each USDC in circulation, for example, can be redeemed for $1. We learnt last year that algorithmic stable coins are not to be trusted, and we learnt this past month that even the most transparent, trusted, and reliable stable coin can exhibit wild swings in price.
Stable coins were created so that crypto users, traders, etc could park profits in something stable as opposed to a volatile crypto asset without exiting the crypto market by exchanging those profits for fiat currency. Furthermore, few banks in the early days were willing to work with crypto businesses, like exchanges. So these exchanges relied on US-dollar pegged stable coins as well. Although this has improved somewhat, improvements are very jurisdiction specific. Just recently CoinDesk revealed that UK banks had begun limiting how much their customers can wire to exchanges and several will not onboard crypto businesses. Moreover, since the collapse of some crypto-friendly banks last month, crypto businesses in the US are struggling to find banking partners, which is limiting the services they can offer their customers, local and international. Kraken, one of the oldest and most reliable exchanges, suspended certain types of transfers and withdraws following the failure of Silver Gate Bank as it tries to find alternative banking partners.
Stable coins are integral to the space. Stable coin transactions reached over 1 trillion US dollars in 2022. USDC, which is issued by Circle, is one of the most transparent, compliant, and frequently audited US dollar-pegged stable coins. There were roughly 42 billion USDC in circulation when SVB failed, which were fully backed by cash reserves and short-term treasury bills. That means that, theoretically, if all the holders of USDC decided to redeem their USDC pre-SVB failure, Circle would have been able to fulfill all the redemptions.
When Silicon Valley Bank failed, the value of USDC plunged to $0.82 on certain protocols. This was because 3 billion of Circle’s cash reserves were held by SVB, and at the time of SVB’s collapse, only 250, 000 dollars of that 3 billion was insured. Despite attempts by Circle to reassure the market, USDC failed to regain its peg until the 13th, as holders of USDC exchanged it for other stable coins or redeemed it for US dollars, afraid that most of that 3 billion would not be recoverable. Furthermore, other stable coins, whose reserves were in U S D C also plunged in value. The only stable coin that benefited from what happened was U S D T, which is the least transparent of all USD-pegged stable coins.
You might wonder- why wasn’t the 3 Billion privately insured or managed in such a way that if a bank failed, USDC holders would be made whole? I do not know either, and I believe Circle dropped the ball there.
What happened with USDC also revealed certain truths. Stable coins are only stable under certain conditions, because, even when their issuers try to do everything right, as Circle did, they are still subject to the vagaries of human nature. I also realized that stable coin issuers are similar to banks. Like banks, they use a fractional reserve model; only 20% of Circle’s reserves are held as cash reserves, the remaining 80% are liquid short-term treasury bills. Just like banks, their success is dependent in the confidence people have in them. If that confidence is eroded for whatever reason, the stable coin can lose its peg, despite attempts to reassure the market. They are also affected by the headwinds that affect whoever might be holding the cash reserves, something called counterparty risk. In the case of USDC, the counterparty was SVB, which failed. Unlike banks, however, they do not have a lender of last resort, which I believe prevents them from taking on unnecessary risk but also leaves them exposed to unexpected headwinds. according to Investopedia, “a lender of last resort (LoR) is an institution, usually a country's central bank, that offers loans to banks or other eligible institutions that are experiencing financial difficulty or are considered highly risky or near collapse.”
What does this mean for stable coins going forward?
There is a need for more robust stable coins, not only because of their importance to the crypto space but also because of their adoption in payment and remittance networks, which is based on their perceived stability. While issuers of stable coins cannot prepare for every single eventually, no one can, it is incumbent upon them to stress test their innovations as much as possible and ensure that holders of their stable coins are always protected. What about crypto users and adopters, what does the depegging of USDC, in particular, mean for users- the reality is that innovation in this space is still evolving and that means things will not behave as intended all the time, and that we need to minimize our risk as much as possible.