Notes 3/11: Circle’s USDC Loses Peg

USDC, the crypto world’s second biggest stablecoin, has lost its peg due to exposure to Silicon Valley Bank (SVB), the bank that liquidated yesterday. The stablecoin’s peg with Tether’s USDT, another dollar-backed stablecoin, fell to as low as 0.86 at cryptocurrency exchange Kraken before recovering. As of this writing, it is still askew at $0.92.

USDC’s peg crashed because investors rushed to redeem their holdings of the stablecoin after it revealed on Twitter that $3.3 billion of its total reserves of approximately $43 billion were parked at Silicon Valley Bank.  

Making USDC Customers Whole

SVB was an FDIC-insured bank, meaning its customers will be made whole to up to $250,000 by the agency. For deposits bigger than this amount, FDIC has said it will hand out receivership certificates. The timeline for redeeming these certificate holders is not yet known, meaning Circle will have to scramble to make up for the missing numbers in its reserves or risk becoming another crypto casualty.

The company does not have many avenues to make up for the shortfall.

It could sell off its holdings of short-term Treasury securities. According to Circle’s January attestation report, approximately 93% of its total reserves, of around $33 billion, were held in securities that matured before 9th March. Typically, companies roll over their securities into newer ones. It could sell the new ones to redeem customers but a premature sale would incur losses, as happened in the case of Silvergate bank.

The report also states that Circle had $8.7 billion in cash, amounting to roughly 21% of total reserves, locked away at regulated banks. If that figure still holds true, then it means around $5.4 billion of USDC reserves is still available to the company.

Circle was reported to be on a hiring spree recently. But its finances are suspect. It had expressed substantial concerns about its ability to function in 2021, when it filed to go public in a SPAC merger. The Fed’s aggressive interest rate policy came to its rescue, it claims. But it must share that interest rate revenue with partners in the consortium that governs USDC.  

Redeeming USDC

Circle tweeted yesterday that it had redeemed $1 billion worth of USDC. Research firm Nansen said $1.6 billion worth of USDC was burned based on blockchain data.

It is important to stress here that both those figures must be taken with a massive grain of salt since figures in crypto do not mean much. Stablecoin issuers can easily claim to have redeemed worthless tokens by burning them out of existence.

The only two avenues for redeeming USDC – Circle and cryptocurrency exchange Coinbase – have paused redemptions over the weekend. That means Circle’s peg, or in this case depeg, may remain constant till Monday.

A Crypto Contagion? Not Really

There’s talk of a crypto contagion resulting from USDC’s depegging. However, USDC’s sphere of influence is limited, even within the small world of cryptocurrencies. Circle minted profits as a market making firm in crypto before pivoting to stablecoin issuance in 2018. It is part of a consortium that includes the likes of Coinbase – America’s biggest cryptocurrency exchange.

But that is not where it is used. The bulk of USDC trading volumes occur on decentralized finance (DeFi) applications. [Rival Tether dominates trading volumes at cryptocurrency exchanges]. These apps are mostly insulated from the turmoil that occurs in public-facing cryptocurrency institutions and exchanges.

USDC was responsible for roughly half of all trading occurring at DeFi exchanges in 2021. It is also used in liquidity pools that lend out crypto tokens for yields. DAI, DeFi’s biggest stablecoin, went off its peg because it used USDC as its peg. Traders have also shifted out of their USDC and DAI holdings into Tether in liquidity pools. These changes are unlikely to affect crypto prices. DAI is an experiment that will likely fail and trading on liquidity pool does not have much of an effect on USDC price, as of this writing.   

Tether Gains

USDC’s depegging is Tether’s gain. Both stablecoins are off their peg. Tether rose above $1 even as USDC’s value shrunk.

Investors are reportedly transferring their USDC holdings into the world’s biggest stablecoin by market capitalization. The logic behind this move is unclear because USDC is somewhat regulated while tether is an unregulated entity with a report card full of controversies and scandals.

But then, crypto investors, as we’ve seen over the years, are hardly a rational crowd. In any case, the depegging was an excellent profit-making opportunity for holders of both stablecoins and exchanges.

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