USDC

Over the past week, the peg of USDC to USD came under strain, after Circle revealed that it had significant deposits in the now-bankrupt Silicon Valley Bank (SVB).As news of this broke, USDC holders began to express doubt, and many started to sell their USDC tokens, causing the stablecoin to depeg by almost 10 per cent.Fortunately, catastrophe was avoided when the Federal Reserve authorised the use of its Deposit Insurance Fund to guarantee any funds still left in the bank by depositors.As of today, USDC has basically regained its peg to the USD- and what would have easily been one of the greatest crypto crashes thus far has been avoided.Naturally, many in the crypto community see this is evidence of why crypto needs to divorce itself from fiat currency.Circle&#39;s Chief Strategy Officer Dante Disparte relished in the irony that Circle, a crypto company, was exposed to risk when a fiat company like SVB was in trouble.And no less than Binance&#39;s CZ tweeted that &#34;Banks are a risk to fiat-backed stablecoins&#34;.From a certain point of view, this is an understandable position. Crypto companies have long been derided for dealing in risky assets that could crash at any time. But now, they are the victims of a crash that they have little fault in causing but have much to lose from.But does this incident really prove that fiat is inherently broken and that crypto is the future? Not quite.SVB&#39;s failure was significant- but not systemic.If we really look at what went down in SVB, we see that it was a combination of heightened interest rates, and a general downturn in the tech sector caused a scramble for cash at SVB to honor withdrawal requests.To do this, SVB first sold off a large portfolio comprising mainly government securities at a loss of US$1.8 billion, which scared off many venture capital investors and resulted in further capital flight. Prominent investors like Peter Thiel encouraged companies to withdraw funds, and by 9 March, SVB was left with a negative cash balance amounting to nearly a billion USD.By 10 March, the bank had been ordered into receivership, with reasons including insolvency and insufficient liquidity.But how much of this was representative of a systemic threat to the banking sector? In other words, how much of SVB&#39;s collapse was a result of economic, rather than management reasons? As it turns out, very little.For a start, SVB is not really a traditional bank. While it holds deposits and uses fractional reserve banking to provide financial services, it serves a unique client base. SVB was formed because traditional financial institutions did not really understand how to serve startups well, and as such, its depositors were principally startups.By 2022, many of these startups were tech companies- and when the sector suffered a downturn, the impetus for withdrawing deposits was born.Its almost certain that many other banks also suffered losses from this downturn- but the question is how much of their portfolio was concentrated in these tech stocks and tech companies.SVB&#39;s unique clientele meant that it was hit hardest, since its portfolio would be less diversified than others. Banks that were less exposed to the tech sector downturn would have more diversified portfolios, and thus would have not taken as significant a hit as SVB.In other words, it was management of SVB and its portfolio, rather than the design of fiat currency or the economy itself, that precipitated the crisis.While there is appreciable irony that a fiat bank is collapsing, to suggest that it is a harbinger of the end of fiat would be quite the stretch, to say the least.Are banks really a risk to fiat-backed stablecoins?Nevertheless, the panic that SVB&#39;s failure caused with USDC holders is something that needs to be considered.Certainly, SVB in this case became a liability to USDC&#39;s value, and holders were right to worry when Circle revealed that it had US$3.3 billion in deposits held with SVB.And if banks like SVB can fail and cause panic among holders of tokens, perhaps there is a good case to be made that when crypto companies deposit funds in banks, the banks may become a risk to the stability and confidence of these stablecoins.After all, if there is indeed a systemic risk that arises in the future, and if fiat banks fail because of it, crypto companies, through little fault of their own, may be exposed to the fallout.But we should not forget that banks are not the only ones responsible for crashes in the crypto space. It is still far too soon to forget the far-reaching impact of the Terra-Luna collapse just last May.Celsius, Hodlnaut, Babel Finance, and many others also saw the crash burn huge holes in their balance sheets, and forced a large portion of these companies into bankruptcy proceedings as well.Terra too was supposed to be stable, collateralised using Do Kwon&#39;s ingenious algorithm. But it also failed spectacularly due to a lack of confidence and unsustainable yields.Was a bank responsible for the crash? Not at all. Instead, it was the ecosystem itself that imploded, without any impact from fiat currency.To suggest that banks are a liability to fiat-backed stablecoins, therefore, is not really wrong in itself- but it is trivial and slightly myopic.In fact, a deeper examination of the crashes and the crypto winter over the past few months would expose some similarities between the crashes that can and should be dealt with.Learning from the SVB crashWhile UST and SVB both suffered from a crisis in liquidity, what really mattered was that both were caused by a crisis in confidence- the price of USDC started trading at a discount because many were not confident that USDC could maintain its peg. In the same vein, the reason why the UST peg came under attack was because there was a lack of confidence in the peg as well.Only in USDC&#39;s case, SVB&#39;s depositors were guaranteed their deposits back when the Federal Reserve took action, effectively bailing the bank out.This restored confidence in USDC&#39;s peg, and the market has demonstrated this confidence by returning USDC to its peg.No such aid was forthcoming for Terraform Labs, and as a result, the tokens crashed in spectacular fashion, wiping out life savings and starting a domino effect that eventually led to a general downturn in the crypto industry.The Federal Reserve, in guaranteeing deposits in SVB, have acted as a lender of last resort for the Bank, shoring up its capital and at least for the time being, allaying fears about whether depositors will be wiped out.This move, however, also proves that such a function is not only necessary, but eminently practical when done right. The lesson that crypto companies should be taking with the SVB bankruptcy and USDC depegging is not that fiat is broken, but that crises can be avoided with proper measures and institutions that are empowered to act as the Federal Reserve has done.In an ironic way, the USDC peg was saved in no small part because of traditional finance, rather than despite it.In effect, what the crypto world would benefit from is this lender of last resort, that deals specifically with crypto firms, and injects capital when no other options exist.Right now, the closest thing in existence is Binance&#39;s Industry Recovery Initiative(IRI), formed in the wake of the FTX collapse. The IRI is intended to help promising, high quality projects and companies that are caught up in short term financial difficulties. Crucially, CZ understands that this is what needs to be done to restore confidence in the Web3 space.But the IRI itself is not perfect.For one, Binance expects the initiative to only last for around six months. Additionally, the fund operates by allowing individual companies to put money into the fund, and consider investment decisions independently from each other on a case-by-case basis.What this means, in effect, is that the IRI is not a permanent feature of the crypto ecosystem, and will not offer a clear plan of action for companies that apply for IRI funding.Lenders of last resort like the International Monetary Fund work because members are required to contribute funds, even when they do not use these funds. The fund also operates perpetually, instead of only being revived when crises occur.With the IRI, however, it may prove to be too little, far too late when members contribute money to the fund only when bankruptcies or selloffs have spiraled into ecosystem-wide crises.Instead, the intiative should be made a permanent feature, with a dedicated group of professionals who understand the space and understand what can be done to help these companies restore confidence in a timely fashion, while enforcing stricter guidelines to ensure that history does not repeat itself.Not only will such an organisation back up the industry&#39;s claim to be able to self-regulate, but it will also provide much-needed security for companies and investors as they put money into developing this volatile but promising industry.They say that history may not repeat itself, but that it often rhymes.Crises may originate from the crypto or from fiat, but the swift action by the Federal Reserve has shown the value of having a lender of last resort.If there is a lesson that the crypto world should take away from the crisis at SBV and Circle, it is not that traditional finance and banks are relics of the past- instead, there remain lessons and institutions that can be adapted to the needs of crypto and the Web3 world.After all, if crypto aspires to replace fiat, it must first prove itself the better option- and the past few months have shown that this is not something that can be taken for granted.And perhaps a first step would be for stablecoin providers to search for more solid ground to place their reserves in. Both traditional banks and crypto tokens can turn into liabilities for these companies- and the key should not be to go all in on one, but instead to diversify the risk properly.

Is CZ Right in Saying That "Banks Are a Risk to Fiat-Backed Stablecoins"? Probably Not.

Coinlive

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