Read our deep dive into why USDC stablecoin broke its peg, and why the loss of three major banks is bad news for crypto
Three big U.S. banks have collapsed over the last few weeks, creating concerns of another financial crisis akin to the crash of 2008. Silvergate and Signature have been forced to shut their doors, citing liquidity issues. And Silicon Valley Bank collapsed in spectacular fashion on Friday, with similar liquidity concerns that prompted a bank run and resulted in insolvency.
And although this triad of failure in traditional finance (TradFi) is a stark warning about the perils of fractional reserve banking and general risk management, it's particularly grim news for the crypto industry as a whole.
Silvergate, Signature and Silicon Valley Bank were all crypto-friendly, providing operational services to major digital asset firms, services that now no longer exist, cutting crypto companies off from integral links to TradFi.
Silicon Valley Bank and Circle's USDC stablecoin
Circle’s stablecoin USDC broke from its U.S. dollar peg amid volatility for the crypto market. This occurred due to Silicon Valley Bank (SVB) collapsing and the USDC stablecoin issuer Circle confirming that a considerable portion of their assets backing their USDC stablecoin were held in the failed bank.
Fortunately, on Sunday night, U.S. regulators announced in a joint statement with FDIC, The Treasury, and Federal Reserve, that SVB creditors would be made whole. With Circle being able to access their $3.3 billion funds locked up in Silicon Valley Bank, their USDC stablecoin returned to its $1 peg.
Why did SVB collapse?
Silicon Valley Bank had invested the majority of its client’s short-term money in long-term U.S. government bonds. Unfortunately these had lost significant value due to the Federal Reserve’s continual raising of inflation rates.
When news got out about this, many of SVB's clients attempted to withdraw their funds. But Silicon Valley Bank had been practicing fractional reserve banking, which only calls for lenders such as SVB to keep a percentage of deposits available for withdrawal, rather than match them one-for-one.
When the bank run on SVB started last week, with depositors hurrying to withdraw all their money, the total being requested to be withdrawn outweighed SVB's liquidity causing the bank to spiral into insolvency.
Signature and Silvergate enter liquidity
On Sunday, U.S. regulators took control of Signature Bank. This was in order to prevent the "systemic risk" of a financial crisis spreading throughout the American banking system and economy.
In addition, Silvergate closed its SEN network on March 3, before revealing in a statement on March 8 that it was entering voluntary liquidation.
Unfortunately, along with SVB Signature and Silvergate were some of the few American banks that were crypto-friendly. They provided various on and off-ramp services to large digital asset firms and crypto exchanges. Through Signet - Signature’s blockchain-based payment system - the bank assisted in facilitating the 24/7 crypto ecoystem. And of course, TradFi is only 9-5, five days a week.
These two vital platforms meant institutional clients could exchange crypto for fiat currency (and vice versa) in real time, day and night, 365 days a year. And together, the two systems were responsible for moving $2trillion in and out of digital asset markets.
The cutting-edge networks allowed key crypto firms to work with fiat money outside of traditional banks' business hours, rather than having to rely on limited services such as the Federal Reserve’s Fedwire or ACH transfers. In this way, Signature's Signet and Silvergate's SEN platforms were fundamental to the business structures of crypto companies like Circle.
The unfortunate effect on stablecoins
As we've mentioned, Circle's USDC stablecoin was adversely affected by the SVB collapse. And it shone a spotlight on the fact that stablecoins might not always be so stable.
For the uninitiated, stablecoins are a form of cryptocurrency created to have a stable value. This is done by linking or 'pegging' their value to an external asset, typically a fiat currency such as the U.S. dollar, or a commodity such as gold.
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. And that's exactly what happened last weekend.
This brings the stability of stablecoins into question and highlights the potential need for more algorithmic stablecoins in the crypto space. It also underscores the importance of having a diversified portfolio when investing, to help soften exposure to market volatility and mitigate risk.