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Seeking Alpha 2023-03-13 12:31:38

USDC's Wild Weekend: I'd Be Getting Out Now

Summary USDC is one of the largest stablecoins in the cryptocurrency ecosystem. The coin lost its dollar peg over the weekend because of SVB exposure from Circle, the coin's issuer. It has since stabilized back above 99 cents. There are still several concerns with USDC even though the peg has been largely restored. Over the weekend, most of the attention in the financial markets was rightfully on Silicon Valley Bank ( SIVB ) and what would happen to that institution's customer assets after FDIC had taken over deposits : Silicon Valley Bank, Santa Clara, California, was closed today by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. Early Sunday evening, it was announced depositors of SVB would be made whole in a joint statement by the US Treasury, the Federal Reserve, and FDIC: Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. But before the joint statement from government and central bank officials, there had already been a rather large impact in a somewhat unsuspecting place. Circle, a major crypto industry business, disclosed it had cash deposit exposure to Silicon Valley Bank: Twitter/Circle Circle is the issuer of USDC ( USDC-USD ). USDC is supposed be a "stablecoin" that has full parity one to one with the US dollar. In a subsequent blog post , Circle disclosed that the exact shortfall due to SVB uncertainty was $3.3 billion: Specifically, USDC is currently collateralized 77% ($32.4B) with US Treasury Bills (with a three month or less maturation period), and 23% ($9.7B) with cash held at a variety of institutions, of which SVB is only one. US Treasury Bills are the most liquid assets in the world and are direct obligations of the U.S. government. These reserves are held in custody by BNY Mellon , and active liquidity and asset management is managed by BlackRock . Bold is Circle's emphasis. The peg panic ensued in part because the majority of the collateral backing the deposits with Circle is held in treasuries, not cash. Even though these treasuries are short-dated, a $3.3 billion dollar hole becomes a significant problem if enough USDC holders rush to withdraw. As a result of the uncertainty surrounding Circle's USDC collateral, the USDC peg went on a bit of a wild ride over the weekend: USDC 7 Day Chart (CoinMarketCap) After plummeting under 90 cents late Friday night and early Saturday morning, USDC peg arbitragers brought the coin back during most of Saturday before popping up to $0.995 following the joint press release news of SVB depositors getting access to funds on Monday. Minting Mechanism Mechanically the way USDC works is fairly simple. Crypto participants who want dollar liquidity on crypto rails deposit their dollars with Circle. Circle keeps those dollars in cash and in treasuries and then mints the crypto coin USDC on public blockchain ledgers for the depositor. One key detail here is that Circle has used Signature Bank ( SBNY ) for processing USDC redemptions and that option is now gone as a result of Signature Bank's closure over the weekend . Circle's CEO Jeremy Allaire said on Twitter late Sunday that reliance is now shifting to Bank of New York Mellon ( BK ): With the closure of Signature bank announced tonight, we will not be able to process minting and redemption through SigNet, we will be relying on settlements through BNY Mellon. He went on to say they're working on a new automated minting and redemption system that could be online as early as Monday - but to this point it's really a guess when redemptions will be back online. There Are Still Risks Beyond the fact that Circle can simply turn off redemptions when it's in the company's interest to do so, Circle also has the ability to freeze assets on-chain and it has previously done so in response to Tornado Cash sanctions last year. USDC Banned Wallets (Dune Analytics/phabc) Circle has already banned 159 wallet addresses on Ethereum and these addresses have a combined value of $8.6 million. Furthermore, Circle still has the overwhelming majority of its depositor collateral in short term treasuries: Collateral (Circle) Even though I view a run on Circle's USDC cash deposits as a fairly unlikely event now that we know that cash hole from SVB is no longer there, it is at least possible that cash reserves could be drawn down and USDC withdrawals halted again in the future. In that scenario, USDC holders would essentially have Circle's duration problem shifted to them and if that's something they're okay with, they should probably just buy the treasury's directly themselves instead. Summary Circle is an important company in the cryptocurrency ecosystem. The USDC stablecoin that Circle issues is one of the most notable assets that lives on crypto rails. Even though derivatives always have an element of risk, I don't believe there is a high likelihood that Circle won't be able to honor all withdrawal requests. It just might take some time to redeem all of them if a large amount of requests are submitted following Circle's implementation of a new redemption mechanism. Given what we learned from the joint release from FDIC, the Federal Reserve and US Treasury, it's unlikely at this point that the USDC peg will fall again due to any bank contagion but it's important to remember there are still several risks in holding Circle's flagship stablecoin. USDC withdrawals can be turned off. Even on chain, USDC swaps can be frozen. In many ways, stablecoins are the 'killer app' of decentralized payment rails but the largest ones still require centralized issuers. This is not ideal because centralized issuers carry regulatory concerns in addition to redemption concerns. It wasn't all that long ago stablecoin issuers were receiving Wells Notices from the SEC. I don't have exposure to USDC, but if I did I'd do my best to minimize it.

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