Stablecoin USDC briefly lost its
peg. What do we learn from this?

Stablecoin USDC briefly lost its peg. What do we learn from this?

One of the top stablecoins by market cap, USD Coin (USDC), de-pegged briefly from the US dollar on March 11 following the collapse of Silicon Valley Bank (SVB). Circle, the stablecoin’s issuer, held $3.3 billion in USDC reserves with the bank, which caused panic as investors rushed to withdraw their funds, assuming USDC could implode because of insufficient backing. However, the amount represented less than 8% of the stablecoin’s reserves.

Still, USDC is designed to always trade at $1. The SVB’s collapse, the largest bank failure since the financial crisis in 2008, caused the stablecoin to trade at 85 cents as investors panicked due to the $3.3 billion stuck at the bank. On March 13, Circle reassured investors by announcing it had received all the funds held at SVB and transferred them to new banking partners.

USDC has since recovered its peg and was trading at $0.99, at the time of writing. The re-peg was a breath of relief to the crypto community, which doesn't need another stablecoin failure after the collapse of UST in 2022. Although USDC has re-pegged, its market cap has dropped by about 19% from $43.6 billion on March 10 to $35.2 billion on March 21.

While the USDC de-peg was brief, it has revealed that centralised stablecoins are exposed to bank risks since issuers like Circle depend on traditional banks to store reserves. Therefore, a stablecoin could collapse if the bank holding its reserves suffers a bank run. Luckily for USDC investors, Circle was not holding all of its reserves at SVB. This is something, stablecoin providers will have to take more seriously going forward: Spreading their counterparty risk.

Centralised stablecoins are also massively used in decentralised finance (DeFi), which means the collapse of a stablecoin can greatly impact this sector. Interestingly, the de-peg was great news for USDC borrowers because they enjoyed a discount of $84.1 million.

That said, the risk of centralised stablecoins will continue to be a thorn in the side of the crypto sector due to the banking risk. Therefore, investors might want to consider decentralised stablecoins like FRAX or LUSD. While these types of stablecoins are still highly experimental and building them is difficult due to the stablecoin trilemma, they are potentially promising. Still, stablecoin creators are faced with the challenge of having to trade off varying degrees of control over the peg, decentralisation, and scalability. As it stands, no one has solved this trilemma yet.

Bitcoin and the banking crisis

The global banking system has been shaky lately, with shares of a few US regional banks declining as investor confidence in banks dropped. Besides US banks, one of Switzerland’s biggest banks has also been impacted by the ongoing banking crisis.

The crisis started with the aforementioned Silicon Valley Bank when the Federal Deposit Insurance Corporation (FDIC) intervened to take control on March 10. 48 hours before this, SVB announced plans to raise $1.75 billion in capital to fill the gap created by its loss-making bond investment. This announcement caused panic among customers, who responded by withdrawing funds en masse, resulting in a bank run. This panic could have been caused by the fact that 88% of SVB’s deposits are uninsured. The bank had earlier invested a percentage of its deposits in long-dated US government bonds, which were losing value as the Fed raised interest rates to combat inflation.

SVB is the largest bank failure since the 2008 financial crisis. Therefore, this event caused panic and contagion across markets. The aftermath of this collapse was the closure of Signature Bank on March 12. Spooked customers rushed to withdraw their funds, forcing regulators to shut down the bank. [1] The declining confidence in banks also travelled beyond the US, impacting Switzerland’s investment bank, Credit Suisse. UBS, a competitor of Credit Suisse, is set to buy the failing bank for about $3.2 billion in a deal arranged by regulators who want to avoid further turbulence in the global banking system.

Another US regional bank, First Republic, is also in trouble as customer confidence plummets. 11 of the largest banks in the US put together a $30 billion rescue package for First Republic to prevent its collapse. Nonetheless, this may not be enough to solve the bank’s issues, which include but are not limited to liquidity and profitability challenges.

The current banking crisis has reminded the world that Bitcoin was created to protect people from the traditional centralised financial system that relies on trusted entities. As we have seen, bad things happen when this trust fails.

While banks were failing this month, Bitcoin’s price action has been on an uptrend over the last couple of days, as per the graph below. However, the price rise may not necessarily mean investors are using it as a safe haven asset just now. It is more likely that Bitcoin investors are anticipating a potential pivot by the Federal Reserve System in the US, believing more liquidity will hit the markets. This does indicate Bitcoin’s role as a liquidity barometer that anticipates the possibility that the current financial system may be at a breaking point and demands further intervention from central banks.

Still, Bitcoin remains a strong alternative to banks since it eliminates counterparty risk. The former Coinbase CTO, Balaji Srinivasan, is a firm believer in this statement, hence why he has entered into a bet, predicting that BTC will hit $1 million by June 17. He is of the opinion that the banking crisis will cause the US dollar to hyperinflate, culminating in a scenario where Bitcoin will hit $1 million. While this bet is absurd and probably a way for Balaji to market himself, people are likely to talk more and more about BTC as an alternative to banks thanks to this marketing stunt.

The emergence of Bitcoin layer 2: A financial system on Bitcoin

People do not typically associate Bitcoin with smart contracts, which is why DeFi is mainly built on the so-called smart contract blockchains. Nevertheless, this is changing as more and more projects strive to build a DeFi ecosystem on Bitcoin through layer-2 solutions. They are keen to take advantage of Bitcoin’s reliable security, popularity, and high liquidity. Some of the most notable projects building a DeFi system on Bitcoin include Stacks, Rootstock, Liquid Network, and Sovryn.

Stacks is a layer-2 network that brings smart contracts and NFTs to Bitcoin, while Rootstock (RSK) is a Bitcoin sidechain bringing EVM-compatible smart contracts to Bitcoin. On the other hand, the Liquid Network is a layer-2 solution that allows the issuance of security tokens, stablecoins, and other digital assets on top of Bitcoin, while Sovryn is a decentralised platform built on Rootstock that offers Bitcoin lending, trading services as well as a decentralised stablecoin.

Microsoft plans on launching a browser wallet for Edge

Tech giant Microsoft could be planning to gain a foothold in the web3 space if recent reports are anything to go by. According to screenshots shared by a Twitter user going by the pseudonym Albacore and other sources, the company could be creating a non-custodian crypto wallet that will be built into its web browser Edge. The wallet has already been built into the latest version of the browser, but it’s hidden and inaccessible to users. Since it’s built-in, it could remove the need for users to add wallet extensions to the browser.

Furthermore, the Microsoft crypto wallet is said to feature a crypto news feed, multi-cryptocurrency support, a decentralised application explorer, a buy button allowing users to purchase crypto via MoonPay and Coinbase, and NFT support. Albacore, who is a software researcher in Central Europe, tested the wallet and claimed it works just fine. However, he said Microsoft may not release the wallet to the public, since it tests many things that never see the light of day.  

This development, even if it’s not official yet, indicates that the crypto sector is here to stay since mainstream companies are taking an interest and exploring ways in which they can position themselves in the sector.