Stablecoins fail to live up to their billing, again. After last year’s Terra blowup, bouts of market stress at Tether and a regulatory crackdown on Binance’s BUSD, Circle’s USDC — one of the most stable stablecoins — is now trying to calm panic over its exposure to now-defunct Silicon Valley Bank, where it had 3.3 billion dollars in reserves. Even if it succeeds, regulators and banks have good reason to remain wary.
Crypto’s On-Ramp ran straight into SVB’s brick wall
As the name suggests, the job of a stablecoin is to behave across crypto markets like a digital dollar without actually being one. The advantages for traders are low volatility for tokens that operate outside the rules of traditional finance and offer access to new and very fast forms of crypto lending. The risks are myriad: investor losses if the dollar fest breaks, crime including money laundering, and financial instability given the market’s $136 billion size and its growing interconnections with TradFi.
The USDC’s hectic weekend underscores yet another reason for regulators to remain vigilant. Unlike Terra, USDC is a stablecoin whose backing is based on cash and dollar assets. The risk for investors is either that these reserves do not exist as advertised – or that a counterparty goes bankrupt, which is exactly what has happened. Just a few months after a CNBC appearance in which Circle co-founder Jeremy Allaire boasted that digital dollars were superior to bank deposits because of the “risk” banks took with people’s money, a real-life bank run at Silicon Valley Bank effectively triggered a shadow bank run on USDC, which at one point fell below 85 cents. Coinbase Global Inc. Stopped USDC Dollar Conversions.
An optimist might argue that assuming the Circle’s revelations are accurate, this looks like a survival crisis. The $3.3 billion trapped in SVB is a small part of Circle’s total reserves of $42.1 billion, of which $32.4 billion is invested in treasury bills and $9.7 billion in cash. Allaire has said that if SVB does not return 100% of its deposits, Circle will cover any shortfall using “corporate resources” or external funds if necessary. This stopped most of the panic selling, and even pushed some crypto evangelists to brag that SVB’s “TradFi” collapse only serves to show the resilience of DeFi.
That’s fine in theory. But in practice this looks like a very hopeful interpretation. The market pressure on USDC highlights what Kaiko analyst Conor Ryder has called the “stablecoin trilemma.” The trade-off for achieving stability in reserve-backed tokens is for investors to place their trust in a centralized entity’s reliability and profitability. At least some of that trust is gone for a while, if not for good. Given the speed with which the selling pressure hit USDC, the size of the stablecoin market and the fact that investors rely on sometimes patchy disclosure – the full details of Circle’s banking relationships have not been revealed so far – this is likely to keep regulators pressured to drag stablecoins into the light.
Also, the events of the past week will likely see fewer banks, not more, getting into the business of partnering with stablecoin sponsors. Counterparty risk, concentration risk, regulatory risk and now interest rate risk will lead to banks becoming more selective when it comes to their customers. In just a few days, we have seen the demise of Silvergate Capital Corp. – which was exposed to the collapsed exchange FTX and had bought Facebook’s Diem in the hope of issuing its own stablecoin – and SVB. In December, Signature Bank openly said it would be more discerning in allocating capital to cryptos including stablecoins. Why should bulge-bracket banks think differently?
So perhaps there is some twisted logic in the fact that an opaque stablecoin like Tether – which has been far more cagey and deceptive about where reserves are held – was a big beneficiary of the USDC’s woes over the weekend, trading at a premium. Given that this market lacks a JPMorganCoin or a central bank digital currency, there is no real opportunity for a flight to quality beyond cashing out. The hinterland between TradFi and DeFi already looked like a no-man’s land — the events of the past weekend will only bring more economic barbed wire. With good reason.
More from Bloomberg Opinion:
• The threat from central banks’ crypto dreams: Marcus Ashworth
• Quick course: Cryptocurrency vs. Reality: Timothy L. O’Brien
• Matt Levine’s Money Stuff: SEC Coming for Crypto Custody
This column does not necessarily reflect the opinion of the editors or Bloomberg LP and its owners.
Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the EU and France. Previously, he was a reporter for Reuters and Forbes.
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