Crypto’s brush with disaster after the SVB collapse

Hello and welcome to the latest edition of the FT’s Cryptofinance newsletter. This week we take a look at Circle’s flirtation with disaster.

Crypto’s banking crisis is in full swing. Silicon Valley Bank, Signature Bank and Silvergate Capital once served as an important trio of lenders happy to take deposits from crypto companies – but now they’re all gone.

The trio’s demise has left an industry with already tenuous links to the established banking system with even fewer options.

That’s a serious problem, but events have also highlighted another industry weakness: unstable stablecoins at a time of acute pressure.

These tokens are meant to be the conduit between crypto and sovereign money, serving as native digital dollars and maintaining their value one-to-one against the dollar at all times. Most daily trading on crypto exchanges is not difficult currency-to-crypto, but the buying and selling of stablecoins against other crypto-tokens.

After Circle admitted a $3.3 billion exposure to SVB, the USDC token briefly collapsed to 88 cents instead of its usual price of one dollar. USDC is the second largest stable coin and is also widely used as a trading coin in decentralized finance.

This is not the first time something like this has happened. Last year, market leader Tethers USDT also broke its peg with the dollar, days after the collapse of smaller rival stablecoin terraUSD. The latter’s failure kick-started crypto’s unprecedented market crash in ’22.

Circle’s de-pegging also risked an emergency that had the potential to dwarf last year’s crash. “This would be bigger than the Terra/Luna collapse. Maybe we would have called it kryptos nuclear winter,” said Larisa Yarovaya, deputy head of the Center for Digital Finance at Southampton Business School.

But the threat was brief. Circle promised financial support and US regulators moved to ensure that deposits at SVB were safe, offering USDC a lifeline that was unlikely to top the authorities’ concerns. The token has returned to the peg.

“There has been some relief as another stablecoin crisis has been averted,” JPMorgan’s Nikolaos Panigirtzoglou said.

Circle’s chief strategy officer and head of global policy Dante Disparte told me recent events amounted to “crypto’s Cuban missile crisis,” a potential disaster averted at the last minute.

In his view, SVB was a “black swan failure” and it was “banks that introduced risks to the digital asset market”. In my view, crypto is genuine The Cuban missile crisis broke the USDC, not a bank’s failure.

Still, many cryptoevangelists have come to Disparte’s conclusion. Ark Investment Management CEO Cathie Wood said crypto was being used as a “scapegoat” for the lapse in banking supervision and that the industry had “nothing to do with banks’ investment decisions, nor the Fed’s decision to raise interest rates”.

Hindsight is always wonderful. SVB had billions in uninsured deposits and bought cheap long-term government debt without hedging against a rise in interest rates. The customers who held the deposits were a concentrated group of similar firms that exhibit a herd mentality. The ingredients for the cocktail were there.

Nevertheless, customers cannot be expected to follow or understand the bank’s business model or risk exposure. That is the regulator’s job, so the industry has a point about the quality of supervision. It is a two-part system, divided into the large, system-important and other.

That said, there’s a world of difference between being a start-up with a couple of people and $100,000 in the bank and someone looking around for a place to park $3.3 billion. It’s no secret that US banking rules limit deposit insurance to $250,000. Ensuring that billions of dollars are completely safe is part of basic risk management, if not from the company then from its equity backing.

“We cannot blame the entire banking system, Circle engaged with these specific banks that have taken risks and this is the result,” Yarovaya said.

Circle has now moved $5.4 billion of cash to BNY Mellon, a designated global systemic bank, so the money is safe. But the episode has underscored two points: crypto is as dependent on the health of the US banking system as anyone else, and that the USDC is now “too big to fail”.

As Carol Alexander, finance professor at Sussex University, told me earlier this week: “Circle had large exposures to SVB and the very significant untying of their USDC stablecoin . . . should be a massive red flag for the entire crypto ecosystem.”

What do you think about the USDC decoupling? Is the fault with the banking system or Circle? Send me an email at [email protected].

Weekly highlights

• US and German authorities, backed by Europol, took down ChipMixer, a popular mixing service, for its alleged involvement in money laundering. Authorities seized approximately $46 million, but estimates suggest the platform may have facilitated the laundering of $2.8 billion in crypto assets. Not surprisingly, ChipMixer was also used by North Korea’s notorious criminal syndicate, the Lazarus Group.

• It’s never too busy for a crypto hack. A decentralized financial protocol called Euler Finance fell victim to a $197 million theft. According to blockchain analytics platform Chainalysis, hackers stole funds in USDC, as well as other coins. In response, Euler Finance did what all helpless DeFi platforms do when they are exploited: offer money “hopefully” it would result in funds being recovered. The reward here is $1 million. Inspiring stuff.

• The list of lawsuits surrounding FTX is growing. This week, plaintiffs filed suit on behalf of US and non-US FTX customers, training their crosshairs on “influencers” who promoted, aided or actively participated in the failed exchange’s offering and sale of unregistered securities. You can read the full lawsuit here.

Soundbite of the week: Operation chokepoint under the microscope

One of Washington crypto’s biggest defenders, Republican Congressman Tom Emmer of Minnesota, came out swinging on Twitter on Wednesday against the government’s action in the last week.

“The administration’s demonstrated effort to strangle digital assets from the US financial system is a lazy and destructive strategy that stagnates innovation and exposes US users of digital assets to less sophisticated regulatory jurisdictions.”

Data mining: Tether and a “flight to safety”

If you had “investors will migrate to Tether token for safety” on your 2023 crypto bingo card, congratulations.

According to recent figures from data provider CryptoCompare, trading between Circle’s USDC and Tether’s USDT token surged a whopping 828 percent to $6.1 billion on March 11, the day USDC began decoupling. This trade indicated that traders were fleeing the USDC for its rival.

Tether’s disconnection last year prompted my colleague Adam Samson and I to ask Tether’s Chief Technology Officer Paolo Ardoino fundamental questions about USDT’s reserves. He said he did not want to reveal the company’s “secret sauce”.

Cryptofinance is edited by Philip Stafford. Send any thoughts and feedback to [email protected].

Your comments are welcome.