SVB collapse shows cryptocurrency fickleness

By Sydney Barrett Last updated Mar 13, 2023

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When the world’s second-largest stablecoin became embroiled in the collapse of a California bank late last week, it echoed the now-famous maxim of Nobuhiro Kiyotaki and John Moore. “Evil,” the economists claimed in a 2001 lecture that was later published as an essay of the same name, “is the root of all money.”

Turning a popular aphorism on its head was a trick used by the professors to stimulate a professional discussion. “Evil is a strong word,” they wrote. “You may find the moral category too rigid for something as lenient as breaking a promise. In this case you might want to change the title to “Distrust is the root of all money”. But that wouldn’t have the same sound.”

The events of the last week have shown that Kiyotaki-Moore may have been right not only in her analysis but also in her exaggeration: people accept and hold money not because it circulates freely and is widely used as a store of value, but because it is helping society overcome the scourge of broken promises. In order for something to aspire to money, it must be free from even the slightest doubt in this regard.

That was clearly not the case with Circle Internet Financial Ltd.’s USD coin, or USDC, the #2 dollar clone behind Tether. News that around 8% of the crypto firm’s reserves were deposited with Silicon Valley Bank, which was shut down by regulators on Friday, caused the stablecoin’s price to fall well below $1, falling to less than 85 cents before recovering . In the language of money market funds — the older, more conventional cousins of blockchain-based stablecoins — USDC has broken the buck. Circle can still keep its promise to redeem all of its coins 1:1 for dollars. But a small doubt that it might not be able to do that arose. If only briefly, USDC has lost its claim to be money.

None of this was the fault of the crypto company. Many young companies have kept their money with SVB, and not all of them are from Silicon Valley. According to a survey by TechCrunch, over 60 Indian startups have their money stuck too. As far as we know, SVB failed because of its executives’ greed for profit: the bank’s own assets were too exposed to long-term interest rates, which are rising due to untamed US inflation. The higher the interest rates, the lower the value of the mortgage securities on the SVB’s books. The greater the unrealized, unhedged losses on these investments, the greater the distrust among bank depositors.

Circle tried to move its funds to another bank, but it was too late. And then the concerns expressed by SVB depositors began to infect USDC investors as well. While all deposits under $250,000 are fully insured, no such safety net is available to token holders, despite seven of the 10 largest so-called liquidity pools running on the Ethereum blockchain using USDC for transactions.

Yale School of Management finance professor Gary Gorton and Federal Reserve attorney Jeffery Zhang have highlighted this regulatory vacuum and how it prevents stablecoins from becoming what they call “no questions asked” money. No one should have to carefully examine a medium of exchange because it should be free from the evil of broken promises. NQA funds need government blessing – and oversight.

Now that regulators have crafted a solution for both insured and uninsured SVB deposits, any doubts about Circle’s ability to redeem every coin at face value may recede as quickly as they arose. “Depositors will have access to all of their money beginning Monday, March 13,” the Treasury Department, Federal Reserve and Federal Deposit Insurance Corp said. in a joint statement on Sunday. Finally, nearly 77% of USDC’s collateral assets are held in BlackRock Inc.’s Circle Reserve Fund, which is 100% invested in short-dated US Treasuries. This part is both fluid and bulletproof.

The bigger concern is systemic. Tremors like this are nothing new in traditional finance or TradFi. In the US alone, money market fund sponsors have taken losses on more than 200 occasions since the 1980s in order to keep up the promise – or pretense – of cash. Only twice — in 1994 and 2008 — have shareholders suffered losses, according to a Federal Reserve Board paper published in Washington last year. (There were also two highly publicized public bailouts after the 2008 global financial crisis and then again during the 2020 pandemic.)

Still, TradFi has access to a perfectly safe form of money in the form of insured bank deposits. In contrast, the burgeoning world of decentralized finance, or DeFi, is handicapped. With the recent collapse of Silvergate Capital Corp. Investors have lost access to the Silvergate Exchange Network or SEN, a popular institutional platform for converting dollars into crypto assets.

If the blockchain is going to host a parallel system for people to save, invest, lend, borrow, and insure—minus the popular custodians of today—it cannot possibly be at the mercy of stablecoins, whose values are even sporadically challenged.

This will likely never happen with central bank digital currencies, which will come with full government support. However, CBDCs are still largely at an experimental stage and it is unclear whether they will be available on public blockchains. When SEN shut down, it looked like stablecoins would triumph over the evil of broken promises after all, ahead of public sector e-money. USDC’s de-pegging, while proving temporary, has shattered that illusion.

SVB collapse shows cryptocurrency fickleness

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SVB collapse shows cryptocurrency fickleness

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