As the name suggests, the job of a stablecoin is to behave across crypto markets like a digital dollar without actually being one. The benefits for traders are low volatility for tokens operating outside of the rules of traditional finance and offering access to new and very racy forms of crypto lending. The risks are myriad: Investor losses if the dollar-peg breaks, crime including money laundering, and financial instability given the market’s $136 billion size and its rising interconnections with TradFi.
USDC’s buck-breaking weekend underscores yet another reason for regulators to keep alert. Unlike Terra, USDC is a stablecoin whose backing is based on cash and dollar assets. The risk for investors is either that those reserves don’t exist as advertised — or that a counterparty goes bust, which is exactly what’s happened. Just a few months on from a CNBC appearance in which Circle co-founder Jeremy Allaire boasted that digital dollars were superior to bank deposits because of the “risks” banks took with people’s money, a real-life bank run on Silicon Valley Bank effectively triggered a shadow-bank run on USDC, which at one point fell to below 85 cents. Coinbase Global Inc. halted USDC-dollar conversions.
An optimist could argue that, provided Circle’s disclosures are accurate, this looks like a survivable crisis. The $3.3 billion trapped in SVB is a small slice of Circle’s overall reserves of $42.1 billion, of which $32.4 billion are invested in Treasury bills and $9.7 billion are in cash. Allaire has said that if SVB doesn’t return 100% of its deposits, Circle will cover any shortfall using “corporate resources” or external funds if necessary. This stemmed 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 to achieve stability in reserve-backed tokens is for investors to put 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 at which selling pressure hit USDC, the size of the stablecoin market and the fact that investors are dependent on sometimes-patchy disclosure — the full details of Circle’s banking relationships haven’t been disclosed so far — this will likely keep regulators pushing to drag stablecoins into the light.
Moreover, the events of the past week are likely to see fewer banks, not more, want to step into the business of partnering with stablecoin sponsors. Counterparty risk, concentration risk, regulatory risk and now interest-rate risk will see banks become choosier about their clients. In just a few days, we’ve seen the demise of Silvergate Capital Corp. — which was exposed to collapsed exchange FTX and had acquired Facebook’s Diem in the hopes of issuing its own stablecoin — and SVB. In December, Signature Bank said openly it would be more discerning in allocation of capital to crypto including stablecoins. Why would bulge-bracket banks think differently?
So maybe there’s a certain twisted logic in the fact that an opaque stablecoin like Tether — which has been far cagier and deceptive about where its reserves are held — was a big beneficiary of USDC’s problems over the weekend, trading at a premium. Given this market lacks a JPMorganCoin or a central bank digital currency, there’s no real option of 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 financial barbed wire. For good reason.
More From Bloomberg Opinion:
• The Menace of Central Banks’ Crypto Dreams: Marcus Ashworth
• Crash Course: Cryptocurrencies Vs. Reality: Timothy L. O’Brien
• Matt Levine’s Money Stuff: The SEC Comes for Crypto Custody
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France. Previously, he was a reporter for Reuters and Forbes.
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