- Circle’s USDC stablecoin broke its $1 peg
- This was instigated by the collapse of Silicon Valley Bank (SVB)
- The USDC stablecoin was partially backed by SVB’s reserves
- SVB’s customer deposits were invested in government debt
- Fractional reserve banking brought into question
Why are stablecoins not always stable?
Stablecoins are a type of cryptocurrency designed to have a stable value. This is achieved by attaching or ‘pegging’ their value to an external asset or a basket of assets, usually a fiat currency such as the U.S. dollar, or a commodity such as gold or silver.
USDC, USDT and DAI are three stablecoins pegged to the U.S. dollar. Despite the potential benefits, stablecoins are not without risks. The main risk with any stablecoin is the possibility of becoming depegged from its external asset and losing its value, as we saw over the weekend.
Why did the USDC stablecoin depeg?
Circle’s stablecoin USDC depegged from its U.S. dollar value amid volatility for the rest of the crypto market.
This happened as a result of Silicon Valley Bank (SVB) collapsing and USDC-issuer Circle confirming that a considerable portion (about $3.3 billion) of their assets backing the stablecoin were stuck in the defunct bank.
When it was revealed SVB were responsible for holding the funds backing USDC, and due to concern surrounding SVB’s liquidity, the stablecoin detached from its $1 peg to fall as low as $0.88.
On December 31, 2022 the Federal Deposit Insurance Corporation (FDIC) reported that SVB held approx. $209 billion in assets. However, because the bank was not transparent regarding these underlying assets and how risky or illiquid they might be, speculation mounted about whether the failing bank could honor all its obligations, including its backing of USDC.
Fortunately, on Sunday night, U.S. regulators announced in a joint statement with The Treasury, FDIC, and Federal Reserve, that all SVB creditors would be made whole.
The announcement confirmed that, as one of SVB’s creditors, Circle could access their $3.3 billion funds on Monday, meaning the USDC stablecoin was once again fully backed. As a result USDC recovered and repegged to its $1 value.
What caused Silicon Valley Bank to collapse?
Silicon Valley Bank had invested most of its client’s money in U.S. government debt, which had lost some of its value due to the Federal Reserve’s ongoing inflation rate hikes.
And the recent stablecoin situation was largely sparked due to a subsequent bank run on SVB. Thanks to fractional reserve banking, which only requires lenders to hold a portion of deposits available for withdrawal, so despite having approx. $174 billion in deposits, when Silicon Valley Bank depositors rushed to withdraw funds the total withdrawn reached about $42 billion. This was almost 25% of SVB’s deposit base.
The assumption of fractional reserve banking is that withdrawal demand will not exceed the deposit base’s pain threshold. Unfortunately, when consumer confidence plummets like it did with SVB, withdrawals skyrocket and there’s a liquidity shortage.
As we mentioned, U.S. regulators swooped in to take control of deposits of the failed Silicon Valley Bank. When the U.S. government announced all depositors would be able to get their funds from today, Monday 13 March, USDC stablecoin repegged and the crypto market recovered.
The situation echoes the Cypriot financial crisis of 2013, involving the fractional reserve system, Cyprus banks’ over-leveraged positions with property companies and the Greek government-debt crisis. However that consequent bank run unfortunately ended with regulators raiding customer accounts.
Trust in transparent technology
Along with the Silvergate and Signature collapses, Silicon Valley Bank is the third major American bank to fall this year. These stories highlight that customer funds are not always safe in traditional banks. And the Silicon Valley Bank scenario in particular, makes it clear how important transparency is. Thanks to blockchain-based digital assets such as cryptocurrency, this transparency is inherent in the technology underlying the financial system.
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