Why did USDC Stablecoin break its Dollar Peg after the Silicon Valley Bank Collapse?

Introduction to the Silicon Valley Bank Collapse

The past weekend was a flurry of activity within the crypto and the banking world in general. The US banking space was hit with a major blow that started on March 9, 2023, and is still a developing story – when the Silicon Valley Bank (SVB) announced liquidity issues in its books that resulted in a bank run.

However, the worst can be said to be more or less over, with the promise from the parties that the depositors at the now troubled Silicon Valley Bank will be repaid from the deposit insurance pool and not the US taxpayer’s money. This is undoubtedly a good move from the US government, proving that they aren’t looking to bail out banks using taxpayer’s money, as was done back in the financial crisis of 2008.

So where does Circle’s USDC and its de-pegging come in?

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

This tweet resulted in a tragic de-pegging of the USDC stablecoin. Why? Because, technically, a stablecoin worth $1 is issued only when there is a reserve of $1 with the company issuing the stablecoin. Now, with the news that $3.3 billion worth of reserves were stuck at a bank that was facing liquidity issues – the news created an environment of fear, uncertainty, and doubt resulting in the de-pegging of the USDC stablecoin.

This was one of the most recent of de-pegging incidents since the de-pegging fiasco at Terra blockchain platform’s algorithmic stablecoin called UST back in May 2022. This de-pegging of the UST stablecoin resulted in the shockwave effect resulting in the implosion of the Terra LUNA ecosystem and finally ended with a nearly $60 billion loss of market value.

While, from the outset, this one hasn’t been as big as the crash that followed the Terra LUNA UST de-pegging fiasco, it is still up there. This is because, in the past week alone, two banks have gone down, namely Silvergate and Silicon Valley Bank – both of which had gained a lot of popularity amid the crypto bull run for being very crypto-friendly banking institutions.

A bit too fast? Well, let’s break it down into a timeline format and take a look.

SVB Collapse Timeline: How a bank collapsed in 24 hours & resulted in the second-largest stablecoin losing its peg!

March 8 – the beginning of the end

The collapse of the legendary Silicon Valley Bank began on March 8, 2023, when the bank announced that it had sold off $21 billion worth of Available for Sale (AFS) securities in its portfolio at a loss of $1.8 billion. Additionally, it had made preparations to sell a further $2.25 billion worth of equity to raise funds to shore up its financial balance sheet.

To understand why the above action is so important, let us first understand, in brief, what led to Silicon Valley Bank’s meteoric growth between 2019 to 2021 and what ultimately resulted in the catastrophe we see before us now. Back in 2019, the Silicon Valley Bank had only about $62 billion in deposits but the next two years saw that reserve exploding and going all the way up to over $200 billion – this was especially in 2021, thanks to its crypto-friendly initiative amid the bull run in the crypto market.

But the problem arose when the bank saw such a huge and quick inflow of funds, it wasn’t able to deploy these deposits in the appropriate way to effectively generate the capital yield they want. So with nearly 40% of all the deposits it had, totalling $80 billion – it invested all that money into an instrument which is known as “Mortgage-Backed Securities” (MBS) under its ‘hold till maturity’ portfolio. This meant while the investments would give money in excess of the capital put in, it could only be redeemed at the end of the maturity period and not immediately. But there was a secondary market where these MBS could be sold off or bought.

That is where the problem started to take from. With the catastrophically rising interest rates in the United States, investors could not purchase government securities with over 2.5x the yield that the MBS that was held by SVB. Thus, the value of the MBS that SVB had invested in plummeted as the US Federal Reserve continued to hike interest rates all through 2022 and even into 2023. With this, the MBS could not be sold off in the market for any amount of profit and the SVB ended up selling $21 billion worth of it for a loss of $1.8 billion. And to account for that $1.8 billion in losses, it was making preparations to sell an equity stake in the company and try to balance out its financials.

March 9 – the gap widens!

The next day, a regulatory filing of the company revealed that the SVB had a negative cash balance of $958 million! That meant that the Silicon Valley Bank was just $40 million short of being a billion dollars underwater! When this news broke, we saw a classic bank run phenomenon occurring across the table with depositors heading to their nearest SVB branches to pull out as much of their cash as they could. Crypto news publication, CoinTelegraph also tweeted a video of one such bank run outside a branch in California.

Customers lining up outside of Silicon Valley Bank at its Menlo Park, CA branch. pic.twitter.com/SDNrSUC1C0

— Cointelegraph (@Cointelegraph) March 10, 2023

USDC, the second-largest stablecoin in the industry by market capitalization, also held a certain amount of their cash reserves in the SVB and when this news broke, they also had put in wire transfers to pull their cash out of the beleaguered bank. Along with that, SVB’s stock price began plummeting faster than ever, losing over 60%, practically overnight!

SIVB Stock Price | Source: TradingView

March 10- SVB goes into receivership, USDC loses its peg

Finally putting an end to the whole drama, regulators stepped into action to take control of the situation before it spiralled completely out of control. The United States Federal Deposit Insurance Corporation (FDIC) announced that SVB,

“Was closed today by the California Department of Protection and Innovation, which appointed the FDIC as receiver.”

On the same day, Circle’s USD Coin (USDC) begins losing its peg to the USD dollar and very quickly goes on to lose as much as 10% of its value and was seen trading around $0.9 amid volatility never seen before.

USDC/USD | Source: TradingView

March 11– $3.3 billion of USDC reserves stuck in SVB!

Within hours of USDC stablecoin losing its peg to the US dollar along with the shutting down of the Silicon Valley Bank, USDC’s issuing company, Circle took to Twitter to reveal yet another development.

2/ Like other customers and depositors who relied on SVB for banking services, Circle joins calls for continuity of this important bank in the U.S. economy and will follow guidance provided by state and Federal regulators.

— Circle (@circle) March 11, 2023

With a little less than 10% of its total US dollar reserves to maintain its stablecoin peg, widespread FUD ensued across the crypto market, which resulted in nearly all of the crypto assets listed taking a major hit across the board. Heavyweights like Bitcoin, Ethereum, and the like lost over 7.5-8% each, while other smaller coins lost even more in a matter of hours.

Silicon Valley Bank was one of Circle’s six partners from the banking industry that they were working with to manage their ~25% of reserves that were held only in cash.

Silicon Valley Bank is one of six banking partners Circle uses for managing the ~25% portion of USDC reserves held in cash. While we await clarity on how the FDIC receivership of SVB will impact its depositors, Circle & USDC continue to operate normally.https://t.co/NU82jnajjY

— Circle (@circle) March 10, 2023

On this day, the crypto space also saw another extremely popular stablecoin temporarily losing its peg, due to its exposure to the USDC stablecoin. DAI, issued by MakerDAO had nearly $3.1 billion exposure to USDC and thus announced that it was proposing a series of measures to limit the effect of USDC on its own stablecoin and to be able to reinforce the peg.

Proposed changes include:

For USDC-PSM:

• Reduce the daily mint limit (gap) to 250 million DAI
• Increase the USDC→DAI swap fee (tin) to 1%

2/

— Maker (@MakerDAO) March 11, 2023

Alongside all of this, major crypto exchanges also began suspending USDC conversions on their exchanges amid their uncertainty regarding USDC’s financial position and its peg to the US dollar. Both Binance and Coinbase said that they would temporarily suspend USDC conversions as the contagion from the collapse of Silicon Valley Bank plays out.

Binance has temporarily suspended auto-conversion of USDC to BUSD due to current market conditions, specifically related to high inflows & the increasing burden to support the conversion.

This is a normal risk-management procedural step to take while we monitor the situation.

— Binance (@binance) March 11, 2023

We are temporarily pausing USDC:USD conversions over the weekend while banks are closed. During periods of heightened activity, conversions rely on USD transfers from the banks that clear during normal banking hours. When banks open on Monday, we plan to re-commence conversions.

— Coinbase (@coinbase) March 11, 2023

March 12- US Regulatory bodies take action

Finally, the larger financial regulatory bodies and other organizations of the government jumped into the mess to take control of the matter and halt it before it goes out of control. The biggest statement came from United States Treasury Secretary Janet Yellen announcing that

“The treasury is focused on depositors’ needs and won’t bail the (SVB) bank out”.

UK Prime Minister Rishi Sunak stated that there were immediate plans underway to ensure the short-term operational and cash flow needs of Silicon Valley Bank UK customers are taken care of.

“We will bring forward immediate plans to ensure the short-term operational and cash flow needs of Silicon Valley Bank UK customers are able to be met.”

Financial news platform Bloomberg reported that the FDIC had been conducting an auction process for SVB on the night of March 11, 2023. It was also reported that the Bank of London has made a formal bid for the UK branch of the Silicon Valley Bank.

Circle, the issuer company behind USDC also announced that the company would cover all of the shortfalls in reserves caused by this catastrophic crash. In a blog post, Circle said it

“Will stand behind USDC and cover any shortfall using corporate resources, involving external capital if necessary.”

With all of this action underway, we saw the overall crypto market regaining its lost steam, with Bitcoin gaining over 8% in a matter of a few hours. The overall crypto market capitalization jumped back above the crucial $1 trillion level.

So, what’s going to happen next in the USDC Stablecoin Depeg & SVB Collapse?

I’m open to the idea

— Elon Musk (@elonmusk) March 11, 2023

And looks like even he cannot make up whether to keep his money in banks to cryptos.

pic.twitter.com/tTMWOHcUom

— Elon Musk (@elonmusk) March 11, 2023

Overall, things seem to be coming to a close, with the promise that all depositors at SVB would be getting their money back and that the government wasn’t ready to bail out a bank at this point. US President Joe Biden also reiterated this over the weekend and as soon as the money is refunded to depositors, things will look brighter once again!

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