February 19, 2025
The USDC stablecoin lost its 1:1 peg due to the collapse of Silicon Valley Bank (SVB), where Circle held a portion of its reserves. This crisis was not caused by crypto but by poor risk management at a US-regulated bank and aggressive Federal Reserve interest rate hikes. The incident highlights the irony of traditional banking regulations failing to protect consumers while crypto offers transparent, trustless alternatives.
Circle Internet Financial is the US company which manages the stablecoin USDC. Stablecoins are a useful financial primitive because they provide the benefits of blockchain infrastructure but at the same time provide the price stability and acceptance of familiar fiat currencies. USDC maintains price stability because Circle redeems each USDC token for one US Dollar, 1:1. Circle can do this because it only creates as many USDC tokens as US Dollar reserves it holds. Circle holds these reserves with various traditional financial institutions (banks) as “cash” (which is immediately liquid) and, to a larger extent “short-dated US Treasuries” (which earns interest for Circle).
Circle, being prudent and managing their operational risk, diversifies their asset holdings at seven US-regulated banks. In January 2023, there were 42.28 billion USDC outstanding and USDb 42.34 in assets held across these banks.
Late last week, rumors of liquidity issues started circulating around Silicon Valley Bank (SVB), the 16th largest US bank servicing diverse clients, but with a large constituency of tech start-ups and venture capitalist firms. It is also one of the banks Circle uses to custody USDC assets.
By Friday evening March 10th, SVB had been placed in FDIC receivership, meaning that access to USDC’s reserve collateral held with SVB would be impacted. This of course meant that all USDC tokens were not backed 1:1 and this implication immediately caused the market price of USDC to “break its peg”, trading at one point at 0.8776 on 11.03.2023. For a “stablecoin” this is naturally catastrophic, not to mention the deep DeFi/oracle impacts on many protocols that rely on the USDC price and perform automated liquidations.
On Sunday March 11th, in order to stem possible bank-run contagion, the FDIC, US Treasury and the US Federal Reserve jointly communicated that depositors in SVB (and by now Signature Bank) would be granted protection including deposits exceeding the current limit of USD 250,000. This messaging had an immediate impact on markets and on the price of USDC, climbing to 0.9869 by Sunday evening before eventually reclaiming the peg on Monday.
Crypto skeptics claim crypto is bad and must be regulated. Circle is a legitimate, audited company backed by industry veterans and ample funding. It maintains an extremely professional operation with dedicated risk management and competent professionals. So how could this happen?
This crisis was not due to crypto, malicious hackers, defective smart contracts, new tech, nor to poor operational security.
This was due to a bank. A US-regulated bank. A KPMG-recently-audited bank. A bank rated “A1” by Moody’s. SVB’s management used depositor funds to buy long-dated treasuries in a low-interest environment, creating exposure to interest rate movements. It was also due to the Federal Reserve, who previously issued benign rate guidance, but in a surprise, all-hands-on-deck maneuver, the Federal Reserve devalued the instruments owned by many banks (not just SVB!) by dramatically raising interest rates over a very short period to combat inflation that it also caused! The dramatic rise devalued bank assets such that they no longer covered the value of deposits. This makes depositors very nervous, and they withdraw their funds. But not everyone can do this and human psychology trumps all: He who panics first, panics best.
Regulations (and by extension regulators) endeavor to keep traditional financial systems safe from different risks. They do this by mandating constraints on what an institution can do and what it can/cannot hold, and how it should hedge risks that it cannot/should not bear.
It is in this case bitterly ironic that all the costly, onerous regulation and auditing provided no meaningful consumer protection and may in fact have had the opposite effect. When was the last time you asked your bank about their duration mismatch and enquired which assets were purchased with your low-interest loan to them (aka your deposits)?
We understand the need for regulation and the resulting consumer protection. But when all the hard work and costs that go into running a regulated and compliant bank or business using banking services can vanish over a weekend in extinction event-level, spectacular fashion, pointed questions must be asked. What protections did those receive for the increased costs and effort? Was it all show?
Legacy players are already trying to place the blame with crypto, but simple observation leads to the nakedly obvious conclusion that crypto had nothing to do with the failings of these banks’ risk management, management or regulators’ rules and ineffective monitoring activities. As the dust settled, crypto and digital assets were nowhere to be found in these banks’ failings.
Demonization of crypto quickly followed to cover for failed interest rate policy, mismanaging interest expectations and blatant lapse in regulatory oversight. Crypto can show us a better path, better transparency and better regulation. Regulation that is immutably engrained in the code, the very fabric of its existence. Society, industry and government can greatly benefit, not by demonizing crypto, but by embracing the new tools of decentralization and trustless financial infrastructure.
