After USDC depegged from $1 last week, many in the crypto industry are questioning whether Silicon Valley Bank’s collapse will have bigger implications on the stablecoin ecosystem.
The supposedly stable stablecoin USDC initially depegged Friday and fell as low as 88 cents on Saturday due to uncertainty around the $40 billion USDC empire, the second-largest stablecoin by market cap. Circle, the issuer of USDC, shared that $3.3 billion, or about 8.2%, of its total USDC reserves were held at SVB. Circle later announced that the reserve risk was “removed” since the funds became available on Monday morning.
USDC’s depeg over the weekend exposed a crucial flaw with existing fiat-backed stablecoin design, Nevin Freeman, co-founder and CEO of Reserve, said.
“If any one of the banks that the stablecoin issuer relies on fails without a bailout, and the issuer can’t fill the hole with their own capital or a new capital injection, that would either force a bank run on the stablecoin and leave the last to redeem with nothing, or the issuer would have to close down and go into bankruptcy to prevent such a run,” Freeman told TechCrunch+. “This isn’t the fault of stablecoin issuers; they have no choice but to rely on fractional reserve banks when providing liquidity to their users.”
Over the weekend, USDC’s price acted as a live prediction market for whether SVB depositors would be made whole, Freeman said. Soon after the Federal Deposit Insurance Corporation and the U.S. Federal Reserve announced that depositors would be made whole, the stablecoin rallied from 97 cents to 99 cents, and only upon banks opening and actually operating did it recover to $1, he noted.
Avoiding severe consequences
If USDC collapsed, it would have had “severe consequences on the whole crypto ecosystem, for instance by causing cascades of liquidations in DeFi lending protocols,” Pietro Saggese, a postdoctoral scientist at the Austrian Institute of Technology, told TechCrunch+. “However, on the other side, USDC is now being traded at par with the U.S. dollar, a good signal that the market might have recovered after this shock.”
While the situation was “unnerving, stablecoin depegging is to be expected in volatile markets,” said Lucas Kiely, chief investment officer of digital wealth platform Yield App. “As we saw, USDC depegging was a short-term factor created by fear around a failed bank where Circle held a deposit. This was a short-term driver and the depegging is unlikely to have a long-term impact on the stablecoin industry.”
USDC wasn’t the only stablecoin that depegged over the weekend: DAI, a crypto-collateralized and decentralized stablecoin, also fell (and recovered) amid SVB’s collapse.
Stablecoins are supposed to be stable
There were two major incidents in 2022 that exposed the repercussions of inadequate regulation and accountability in the stablecoin industry: the collapse of algorithmic stablecoin Terra, causing a ripple effect throughout the crypto economy, and the bankruptcy (and downfall) of FTX in November.
The depegging of stablecoins could itself have follow-on effects. “It’s still too early to draw conclusions, but the collapse of SVB might have intensified the investors’ fears in a moment of generalized lack of confidence in the crypto sector,” Saggese said. “We cannot exclude a relevant role of speculators, however,” he added.
While some stablecoins are backed through cash reserves, others are backed by crypto assets. Most people in the industry view stablecoins backed by cash or bank deposits as the safest bet, though. (USDC is backed through reserves consisting of a mix of cash and short-term U.S. Treasury bonds.)
“Stablecoins could perhaps be renamed, but this is just semantics,” Kiely said. “They are stable in comparison to more volatile digital assets like Bitcoin, but not compared to cash, which is less volatile.”
But it’s important to remember that stablecoins, like any other kind of asset, carry investment risk. “They are subject to volatility and investors hold these assets at their own risk,” Kiely noted.
Others in the crypto industry have more acerbic views of stablecoins in their current form. “USDC is a U.S. dollar stablecoin that is fraud on its face,” said Terrence Yang, managing director at Swan Bitcoin. “They are not stable and they are not backed by U.S. dollars. These should be called U.S. dollar-denominated crypto IOUs.”
Rebuilding trust and regulation ahead
Stablecoins, as well as centralized exchanges, sit “on the interface between the traditional and the crypto financial systems,” Saggese said. “Their pledges of stability are not guaranteed, as well as their promises of full collateralization. Systemic risk might stem from links between traditional and crypto finance. As the recent events showed, this concern is real.”
Governments and financial regulators might intervene to mitigate risks from the banking system and to protect customers from huge financial losses, Saggese thinks. “I believe that this event will increase even more the party that invokes stricter regulation on stablecoins and other actors of the crypto ecosystem such as centralized crypto exchanges.”
If anything, this latest market event “will trigger more interest in the stablecoin sector among global regulators,” Kiely said. “This can only be a good thing for the industry, which needs much clearer guidelines for more institutions to enter. Hopefully, the result of this is greater and greater clarity for this burgeoning asset class.”
If this destabilization can happen to USDC, “the best of fiat-backed stablecoins, it can clearly happen to the rest of them, so trust has been shaken throughout the whole industry,” Freeman said. “But the crypto world understands that this was an issue with fractional-reserve banking, not with Circle or Coinbase, and certainly not with the technology itself. If and when commercial banks can be taken out of the loop by stablecoin issuers, the industry will celebrate and recognize that reduction in risk.”
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