Silicon Valley Bank's meltdown puts stablecoins under a microscope

Jeremy Allaire, Circle
Circle CEO Jeremy Allaire says the company and the USDC coin are operating without disruption following last week's SVB closure.
Stefani Reynolds/Bloomberg

While Circle's USDC stablecoin has largely recovered from the immediate impact of Silicon Valley Bank's collapse, the brief struggle adds to a series of challenges that have shaken confidence in stablecoins. 

Stablecoins — a type of cryptocurrency backed with reserves on a one-to-one ratio, normally traditional currency or treasuries — were once seen as an answer to the volatile swings in valuation that bitcoin and other digital assets had become famous for. And then came the 2022 collapse of the Terra stablecoin and Tether's $41 million fine for failing to disclose its stablecoin was not fully backed by U.S. dollars and other traditional currency.

One of the highest-profile stablecoins, Circle's USDC, lost its one-to-one peg, or ratio, as Silicon Valley Bank collapsed. Circle had about $3.3 billion of its $40 billion of USDC reserves at Silicon Valley Bank. 

"People underestimate the operational risk of stablecoins," said Douglas Landy, co-head of the New York-based White & Case's Financial Institutions Industry Group and head of the law firm's U.S. Financial Services Regulatory practice. 

At Circle, the $3.3 billion in reserves that were stored at Silicon Valley Bank could not be immediately accessed, contributing USDC to decline as low as $0.88 on Saturday. On Monday morning, Circle announced the $3.3 billion was again fully available following the U.S. regulators' decision to back depositors of Silicon Valley Bank and Signature Bank, a cryptocurrency-focused bank that regulators closed on Sunday. 

Circle said it did not have deposits at Signature Bank or Silvergate Bank, another cryptocurrency-focused bank that closed last week. Silvergate had earlier discontinued the Diem stablecoin project after acquiring assets from Meta.   

"The security of stablecoins will always reflect the stability of the banking sector and their issuers," said Martin Hargreaves, chief product officer at Quant, a payment technology company that specializes in blockchain and distributed ledgers, adding the events of the past week to "cast a shadow" over stablecoin development.

Circle, which has expressed an interest in obtaining a bank charter, has taken several steps to expand USDC, including a partnership with Ava Labs to bring stablecoins to new consumers and merchants. Circle's core business is its crypto exchange, and the company has added more payments and financial services over time as it attempts to build a financial super app. 

In a post on Circle's site, CEO Jeremy Allaire said USDC is collateralized 77% with U.S. Treasury bills, and 23% with cash held at a variety of financial institutions, which until Friday included SVB. Circle last week deposited $5.4 billion with BNY Mellon to reduce its bank exposure. 

BNY Mellon is "one of the largest and most stable financial institutions in the world, known for the strength of its balance sheet and as a custodian," Allaire said in Circle's statement. Circle did not provide comment beyond Allaire's statement and Monday press release. 

Another major blockchain company, Ripple, reported exposure to SVB in a social media post written by Ripple CEO Brad Garlinghouse. Ripple's distributed ledger technology underpins the XRP cryptocurrency, and Ripple's technology also supports cross-border payments for dozens of banks and other clients. Garlinghouse's tweets said Ripple's business was operating without interruption. Ripple did not provide comment for this article.

"The reality is that counterparty risk is a risk of doing business," said Tal Kirschenbaum, CEO and co-founder of Ledge, a Tel Aviv-based payments company. "However, the more redundancy a company can build into its operations and infrastructure, the lower the risk."

Concentration risk is one of the biggest risks that companies and banks face, Kirschenbaum said, adding that it is crucial to identify those risks and ensure that there are mitigating strategies in place as a hedge.  

Companies will likely accelerate a multibanking strategy to minimize the risk of holding funds or operating through only one institution. This applies to both fintechs that facilitate money movement as well as other companies that require standard banking services. However, while this diversification minimizes risk, many companies may not be prepared for the operational complexity involved in running a multibank strategy, Kirschenbaum said. 

Managing multiple accounts across several banks requires broad and accurate visibility into cash balances, as well as cash flow management and reconciliation, making it challenging to manage, Kirschenbaum said. 

"Companies will need tools that can aggregate balances across banks in order to solve the visibility challenges that will arise, as well as tools that can normalize the various different data types and schemes that each bank has in order to reconcile payments quickly and accurately," Kirschenbaum said. 

Stablecoin issuers have to store the assets that make up their balance sheets in institutions such as banks or brokerages, according to Landy. 

"Those entities are subject to risk of failure or risk of disruption. There is a risk of not having immediate access, or the markets not functioning," Landy said.  "If the markets aren't functioning properly, the overcollateralization that you have becomes an under collateralization."

It's likely that most stablecoin issuers store assets in accounts larger than the $250,000 threshold for FDIC insurance — and if they were to spread their accounts widely enough to fall under that $250,000 mark it would create management and efficiency challenges, according to Landy. 

"A delay in accessing funds can be an issue. If the reserve funds are tied up in a place where you can't get to them right away, if you are no longer one-to-one with your assets, does that mean you are required to go out and raise more capital? Or redeem enough coins until you are back at one-to-one? Or do you just use the stablecoin at a discount?" Landy said, adding that stablecoin regulations aren't clear on those issues. 

That lack of clarity has led to political battles over the reserves that back stablecoins, as legislators pressure stablecoin issuers to ensure stablecoins do not have risky assets acting as reserves, such as commercial paper.  

While bank deposits would not appear to be risky, it was a lack of access to a commercial bank that caused Circle's trouble. Lingering challenges for stablecoins could draw more attention to central bank digital currencies, which would have a more direct connection to central banks such as the Federal Reserve. CBDCs have many of the same use cases as stablecoins.

"CBDCs do not have the profit motive. With private stablecoins, the first order of business isn't to make it as safe as possible, but to make it safe enough to make money off of it," Landy said, adding that there are challenges to CBDCs as well. "If a CBDC is intended to replace Fiat, and it's not backed by anything except the full faith and credit of the U.S., then you have the issue that libertarians that back crypto don't like. That's the ability of the government to devalue the currency on its own."

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