The Banking Crisis Chapter 1: USDC & Circle

Hey everyone,

Today’s post is an emergency one going out in the wake of the Silicon Valley Bank (SVB) collapse.

It seems we’re in a phase of the crypto cycle where apocalyptic-sized events strike weekly. A couple of months ago, the market was left grappling with the aftermath of the FTX debacle. Then, a couple of weeks ago, regulators went for Binance’s head, and now USDC, the “safest” stablecoin, has de-pegged from its $1 value.

Fun times, indeed. I, like the majority of crypto, never anticipated USDC to be the next domino to fall. Still, it's a stark reminder that there’s a possibility of anything happening, no matter how crazy it sounds.

USDC Depeg

As I write, USDC has depegged and has hit lows of 84 cents. BUSD and DAI have also suffered, thanks to their collateral exposure to USDC. From the perspective of stablecoin infrastructure, the crypto market is feeling the pressure.

Interestingly, non-stablecoin crypto assets, especially BTC and ETH, have rallied about 3-4% as capital drains from USDC. While this might seem bullish, it's most certainly a market distortion caused by people fleeing from USDC.

What’s actually happening

Circle's official correspondence this morning discussed the portion of their Treasury stuck with Silicon Valley Bank. The story begins with SVB, which made headlines last week for its spectacular downfall, reminiscent of Lehman Brothers' collapse in 2008.

Circle, the company behind USDC's issuance, redemption, and backing, holds a significant portion of their cash Treasury with SVB. Unfortunately, this amounts to around $3.3 billion.

USDC has become a crypto darling because of its 1:1 backing with actual US dollars and Circle's US-regulated status. Furthermore, Deloitte audits Circle's reserves, which are disclosed in monthly attestation reports.

The market rewarded Circle for its transparency and trustworthiness. But, the real prospect of the $3.3 billion sitting at SVB going to zero has caused USDC’s de-peg.

As Circle's Chief Strategy Officer points out, USDC is a minor downstream contagion from a more significant collapse. SVB, the 16th largest bank in the US, holds nearly $200 billion in customer deposits and serves many well-known startups. Their collapse could signal a looming crisis.

Scenario Analysis 

Let's explore some possible scenarios. The worst-case scenario is straightforward: USDC goes to zero, wiping $40 billion from crypto and losing a key liquidity platform. This would trigger a massive crypto sell-off, with BTC dropping below $10k and ETH below $500.

However, there's a more optimistic scenario:

Assuming the downside is capped, consider this.

• Around 77% of Circle's reserves are held in short-duration T-Bills, which won't reach zero.

• The remaining 23% of reserves are cash held at banks, including one-third at SVB.

• So even in a worst-case scenario, where every bank holding Circle's cash goes bust, USDC should still be worth 93 cents.

Other sources estimate USDC's fair value between 91 and 98 cents. There's also the possibility of Circle plugging the $3 billion hole through equity, an intervention from Coinbase (an investor), or interest in T-Bills covering the loss over time.

In this case, USDC should restore the peg and, at worst, take a haircut on the market cap. Rest assured everyone; this situation is fundamentally different from Terra’s.

It’s also worth remembering that if it weren't the weekend, arbitrageurs would buy USDC in the spot market and redeem it 1:1 through Circle to restore the peg. 

However, since banks are closed, panic selling of USDC continues in the spot market, which has exacerbated the depeg unreasonably.

And so, considering everything, this is likely an overreaction.

Choppy waters ahead

Crises like this often evoke the sensation of being caught between a rock and a hard place while standing over a trap door. But instead of freaking out, let's put on our big kid pants and tackle the situation with a level head.

The key here is to think critically and analyse the potential scenarios. Don't let panic cloud your judgment – take a step back, weigh your options, and make decisions based on your convictions and understanding of the situation.

What I can say with complete confidence is that this crisis is far from over. The collapse of SVB seems to be part of a larger, looming crisis. One that could make the USDC depeg look like a walk in the park.

No matter how big that crisis may be, it’ll be one that we can overcome with a clear mind and rational thinking.

That’s all for today. I’ll return to your inbox on Monday to discuss SVB’s collapse.

Thanks for reading,

— Luca