The second-largest stablecoin by market cap, USD Coin, was rescued by the government in March, proving that it can indeed compete with banks.
Stablecoins May Also Encounter a Banking Crisis
USD Coin (USDC), issued by Circle, has long been the “good guy” among stablecoins — second only to the sometimes-troubled Tether in market capitalization. Circle’s model is based on investing in cash and short-term Treasuries and provides transparent disclosures. This is also the basic model that Congress has adopted when trying to pass stablecoin legislation, but it is not wise.
This structure has worked very well for Circle for some time. Despite Tether’s first-mover advantage and other advantages, Circle is nearly catching up in market capitalization. By the time Terra/Luna collapses in May 2022, Tether’s share of the dollar-based stablecoin market has fallen to less than half, while Circle’s market share has reached almost 40%.
As Circle wrote in its “Trust and Transparency” blog series last July:
“Comparing Circle to those trusts or banks that use a fractional reserve model is like comparing apples to oranges (two fundamentally different things that cannot be compared). We will not lend USDC reserves to anyone , Circle’s USDC is a fully-reserved U.S. dollar digital currency. Unlike banks, exchanges, or unregulated institutions, Circle cannot lend USDC reserves out…”
This is a point that Circle has repeatedly made in the field of public opinion and in Washington, D.C.
As Circle CEO Jeremy Allaire testified before Congress: “A fully-reserved digital currency model, such as USDC, where 100% of assets are held in high-quality assets such as cash and short-term U.S. It is fully reserved in the form of liquid assets, which is not the same as bank deposits. Bank deposits are the process by which banks receive deposits and re-mortgage and lend.”
Sounds great for stablecoin holders! Customers’ money is completely stored in a safe place, and their money is marked with the customer’s name, and can be easily withdrawn and used. Risky investment in short-term treasury bonds will not expose customers to the risk of loss of funds.
So, as a non-bank institution, how can such security be achieved? The answer is “cash” (that is, bank deposits) and short-term Treasury bills. These short-term Treasuries include shares in money market funds and Treasury-backed repurchase agreements with banks and other institutions that may hold long-term Treasuries. In addition, transparent disclosure of these assets is also necessary so that the market can generate trust in these assets.
As of the reporting date, Circle’s cash was deposited with the following U.S.-regulated financial institutions: Bank of New York, Citizens Trust Bank of Mellon, Customer Bank, Commercial Bank of New York, a branch of Flagstar Bank of North Carolina, Signature Bank, Silicon Valley Bank, Silvergate Bank.
Thus, over the course of three days in March, the “full reserve” USDC-backed asset became an enviable portfolio for distressed credit investors. So, too, is USDC itself. Under the weight of the aforementioned disclosures, USDC began to fall, and when Circle revealed that $3.3 billion was actually stuck in SVB, USDC dropped even more in value despite attempts to withdraw it.
1/ Following the confirmation at the end of today that the wires initiated on Thursday to remove balances were not yet processed, $3.3 billion of the ~$40 billion of USDC reserves remain at SVB.
— Circle (@circle) March 11, 2023
USDC traded below $0.9 that weekend — until the government announced it would back uninsured deposits in bankrupt banks.
The rhetoric that “we don’t lend out reserves” has always been absurd, and now USDC has gone through a 48-hour walkthrough that further clarifies it. To truly achieve “full reserves” is to deposit all reserves with the central bank.
Otherwise, claiming that something less than the full reserve is “full reserve” is extremely misleading. Uninsured dollars in banks (USDC probably needs at least some of them, and there are plenty of them anyway) are loans to those banks as they are converted from digital currencies connected to the blockchain system to traditional currencies It is an important bridge connecting the traditional financial system and the digital currency system. Circle is issuing demand liabilities and making venture loans, so it’s a bank.
In March, the transparency of its asset book led to the loss of liabilities (the larger the bank user deposits or USDC volume, the greater the liabilities, because these funds need to be paid to customers, so they are liabilities), although they did not face any losses in the end , but that suggests it’s a bank. And Tether, which is relatively riskier but subtly less transparent, regained a lot of market share in March, so it is also a bank.
So the emerging consensus on how to make “stablecoin payments” stable remains shaky. However, from a financial stability perspective, USDC’s drop in value is not the most important thing. The big part of the story is when Circle got bad news from the bank and tried to withdraw $3.3 billion from the bank.
Stablecoins – Unstable Deposits
While $3.3 billion in funding does not change the fortunes of SVB in this case, it is easy to imagine a situation where the stablecoin, operating on behalf of its holders, puts pressure on systemically important counterparties. If Circle succeeds in getting funds out, it would be great for stablecoin holders, but it could come at the cost of system stability.
Between March 6 and March 31, Circle withdrew approximately $8 billion in USDC-backed deposits from the banking system. From a macro perspective, $8 billion is nothing. But for some particular banks, it could mean everything; someone has to act as a marginal counterparty when the bank is in survival mode.
In line with broader trends in the banking market, Tether moved about $5 billion in deposits out of deposits into repurchase agreement transactions in the first quarter. Even if the funds end up going back to the exact same borrowers, costs will increase and there may be some temporary disruption. More likely, someone lost their source of financing.
But isn’t this the fault of bad borrowers (aka banks) rather than stablecoins fulfilling their fiduciary duties? After all, holders redeemed about 25% of the outstanding USDC stablecoin in March, more than $10 billion! Circle must be liquid to meet these obligations.
However, the presence of non-bank stablecoins is increasing systemic vulnerabilities by entering intermediary chains. Blockchain data shows that most holders of Tether (USDT) and USDC hold amounts that should normally be insured by the Federal Deposit Insurance Corporation (FDIC).
So if you exclude non-bank stablecoins from intermediary chains (or require them to become banks), you are left with sticky, insured depositors in the banking system.
That is, non-bank stablecoins are effectively aggregating insured deposits and converting them into uninsured deposits and other wholesale financing in order to provide cryptocurrency services to customers. And these financings are at risk of meeting fiduciary obligations at the first sign of trouble. If stablecoins are really “payment stablecoins” as Congress claims, they should be just a payment technology and exist under the deposit book of the banking system. Non-bank stablecoins can achieve security for themselves, but at the same time introduce risk to the entire system.