SVB, Circle and the Fed walks into a bar...

Silicon Valley Bank, the 16th largest bank in the US, failed on March 10th, becoming the biggest bank to fail since Lehman Brothers in 2008.

One of the fallouts from the SVB’s collapse was the stablecoin USDC broke its one-to-one dollar peg. Its price plummeted to a historic low of 88 cents on the dollar. The market was jittery about the coin’s ~$3.3 billion deposit lying in Silicon Valley Bank.

We wonder if Circle, the operator behind USDC, would have been able to maintain the peg if the deposit in SVB was lost entirely? Or, if Circle could have taken any actions to mitigate the depegging event?

USDC is much more important than a mere stablecoin in the ecosystem (there are several more with USDT- Tether being the most reputable). Being the second largest stablecoin by market capitalization, and the largest with proven resources backing it, USDC is essential to the health of the Web3 economy.

The stablecoin business is unique, people park their dollars and don’t receive any interest on their deposits. Circle, on the other hand, earns interest on these deposits. So, why do people use stablecoins as they do?

For one, the confidence that they can easily and reliably exchange it 1-1 for USD. It allows investors and traders to easily move in and out of positions and hold their profits/capital in USDC. Removing the headache of managing the wide fluctuations in cryptocurrency prices while still participating in the crypto economy. This convenience has made stablecoins critical to the ecosystem and been instrumental in increasing how people participate in crypto ventures and the Web3 space.

To ensure that it always has liquidity, Circle holds the money invested into USDC, in cash and short-term US government debt. This allows it to process redemptions easily without taking on any undue risks.

Circle earned a massive windfall on its deposits as interest rates rose. In an interview in January 2023, Circle founder Jeremy Allaire said, “Monetization really scaled up in 2022.”

Let’s look how Circle generates revenues – Other than earning interest on the cash and short-term US government bonds backing USDC, Circle also makes money from its Transaction and Treasury Services (TTS). According to it’s 2021 presentation, Circle forecasted generating $40 million from managing the pool of money backing USDC as well as $65 million in transaction fees.

USDC’s market capitalization as of 16th March 2023, is ~$38 billion. In their statement on 14th March, they have disclosed “as part of our ongoing initiatives to strengthen the USDC reserve, we now hold the cash portion of the reserve at BNY Mellon, except for limited funds held at transaction banking partners in support of USDC minting and redemption. The majority of the reserve is invested in the Circle Reserve Fund, managed by BlackRock and custodied at BNYM, which is principally comprised of short dated U.S. Treasuries.”

However, investors fear was on a rampage, and after the sagas such as Terra-Luna and FTX/Alameda Research, they are tired of big announcements and lost funds. The run for the banks began.

Throughout the saga, Circle has maintained that it would defend the peg even if the ~$3.3 billion deposited in SVB was lost. It has ample reserves elsewhere and would make USDC holders whole using company funds or raising money from investors.

Prices recovered on Monday when the regulators stepped in with decisive action. While SVB had gone bust, the deposit holders’ capital was safe and would be made whole. This restored confidence in the coin and allowed it to recover it’s peg, one USDC could once again be converted to one US dollar.

Alas, damage has been done and confidence is low once more. Or to be more accurate, remains low since Q1 2022.

We are hopeful that this is the end of it, but we are confident we are yet to see the ripples that this is due to create. From regulators, from filling the void of SVB (and silvergate that shut down around the same time), and how investors’ confidence will take time to be restored in the form of coin value and participation in new projects in the ecosystem.