Notes 3/13: USDC’s Peg Is Still Wobbly, Bitcoin Price

Circle’s USDC may have survived a crisis over the weekend after regulators stepped in to bail out Silicon Valley Bank (SVB) depositors, but it is not out of the woods yet.

The stablecoin, which is extensively used in the decentralized finance (DeFi) ecosystem, faces a fresh existential threat this week. A hacker made off with 34 million USDC in a flash loan attack at lending protocol Euler Finance. [Flash loans are loans made without collateral backing].  

The attack further undermines confidence in the token and could cause it to, again, move off its peg. USDC’s extensive use in DeFi places it in a precarious position in that a depegging event could have a domino effect on other tokens and protocols. In turn, it could trigger a wave of liquidations in smart contracts that hold the stablecoin and accelerate its loss of peg.

USDC Liquidations  

Fluctuations in USDC’s peg over the weekend have focused attention on the stablecoin’s role within DeFi. There, it is an important source of liquidity and is used as collateral stored in smart contracts. Such contracts are programmed to liquidate their holdings at a loss if the overall value of holdings falls below a certain figure.

According to a CoinDesk report this morning, there were $70.8 million in positions that can be liquidated between $1 (USDC’s peg) and $0.90. [As of this writing, that figure has declined to $45.4 million].  

The decline is not a vote of confidence in USDC’s reserve management capabilities. Rather, it reflects confidence in the Fed’s assurance that uninsured deposits at regulated banks will be backstopped by the agency.

Multiplying Risk  

The Euler Finance hack attack is a double setback for USDC and DeFi. On the one hand, tens of millions of USDC are floating around in the open. They can be used at cryptocurrency exchanges to induce selling pressure on the token.

In the past, hackers have taken advantage of loopholes in the functioning of DeFi protocols to multiply their holdings by using leverage and moving tokens rapidly through many DeFi lending protocols. USDC’s status as a stablecoin makes it portable through various protocols. Hackers could use their tokens to increase their holdings of the token and cause havoc in DeFi.

The second reason why it is a setback for DeFi is because of USDC’s complicated position in its ecosystem. The token plays many roles, from being used for borrowing and lending to acting as a reserve asset for another stablecoin DAI.

In fact, DAI is the biggest holder of USDC on Ethereum’s network and its peg stability module (PSM), which is used to ensure adequate reserves to back its stablecoin, increased its holdings of USDC today.  

The interdependencies between USDC and various entities multiply risk associated with a loss in its peg. An adverse occurrence or event will quickly ripple through the stablecoin’s ecosystem of supported cryptocurrencies. And an increase in supply of USDC tokens, released from smart contracts, will force traders to sell, and launch a downward spiral in its price.

Since DeFi is an unregulated Wild West, the Fed will not be around to bail out the stablecoin this time around.

Bitcoin Price Pump

Bitcoin price popped this morning to a range above $24,000. Right now, it is at $24,160, up 9% from its price a day earlier.

The surge is surprising considering events over the weekend: the world’s second biggest stablecoin almost went out of business because it had deposits stuck at a bank. As it turns out, it was a wave of short position liquidations of the cryptocurrency that pumped up its price. This is the second such exit by traders in less than a week.

With the closure of Signature Bank, crypto businesses have very few options left to park their deposits. Circle’s problems also cast a spotlight on how dependent the cryptocurrency ecosystem is on regulation. It was only after federal authorities released a joint statement promising to make depositors at Silicon Valley Bank whole that trader confidence was restored in the stablecoin. But the chances that regulation will happen anytime soon are dim.

And so, with each passing day, traders are becoming more certain about crypto’s future. Their actions are proof of their lack of faith in it.

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