Stablecoins: An Example Of Irony And Reverse Contagion

Nick Jones of Zumo writes that true resilience needs different ways to handle money.

The aftermath of Silvergate Bank, Silicon Valley Bank (SVB), and Signature Bank, the second and third greatest bank failures in US history, is ironic for those who have followed the digital asset market.

Central bankers continue to warn about systemic risks from crypto and other digital assets, but a licensed US bank collapsed, jeopardizing USD Coin (USDC), a fiat-collateralized stablecoin pegged to the US dollar.

The irony of reverse contagion was that distress from the traditional financial system threatened crypto stability, with USDC, a pillar of the “DeFi” ecosystem, dropping to a record low of 86 cents on news that Circle had $3bn+ of USDC reserves at SVB.

That would have been ironic enough if not for the fact that fear and panic spread from traditional banking to crypto and were amplified by the old world’s weekend bank closures.

Speculators ran amok trading the 24/7 USDC secondary markets while fiat redemptions remained locked, causing a weekend of high volatility in markets globally “waiting for Monday morning” and the decisions of the few on which the markets have become so dependent.

It’s upsetting and ironic to see market players moving out of USDC, the transparent US-issued stablecoin supposed to do everything by the book, and into other stablecoins like Tether (USDT), which have a reputation for being non-transparent and jurisdictionally hard to pin down.

When investors run away from an asset that should have been the safest of all (1-to-1 reserves held in cash in US banks and short-term US government debt), we can draw our own conclusions about how strong the financial system is.

It’s surprising that some quarters and headlines seem to think this is a crypto or tech-related failure: poor customer choice and risk management separated from the US financial system.

Let’s be clear: there was no question that SVB’s risk management was not up to par. But to leave it at that would hide the role that central economic planning and interest rate policy played in it.

SVB bought long-term securities in a very low-interest rate environment when the Fed provided no sign it would increase, then found itself offside in a comparatively high-interest rate environment and needed to sell at a loss to fulfill mass withdrawal demands: duration mismatch followed by a liquidity crunch.

This was the Fed “hiking until something breaks” and an early victim of crisis-driven, reactive policy. The Fed was slow to respond to the “transitory inflation” story and then raised rates at a record pace, which had never happened before.

We don’t need to be reminded that the current banking system and the fractionalized reserve model are games of trust that are losing trust in a digital world where information and money move faster than ever.

As the panic spreads, shares in many European banks are getting hit hard, and UBS has agreed to “save” Credit Suisse in a “emergency.” As always, the general public pays for the mistakes of those who make decisions.

Digital assets and decentralized finance were created with the idea that there could be an alternative to this system that uses structures that are different on purpose—a system that, over time, doesn’t depend on central economic planning and doesn’t need to depend on other systems.

This might explain why Bitcoin went up 10% while bank stocks all over the world fell and trading was stopped after SVB and Signature Bank failed.

Despite alternative finance’s prospects, it’s troubling that the approach seems to be to double down on the traditional financial system, even as it displays its fragilities, and clamp down on any crypto activity that touches it.

Some of the most important organizations that linked the “crypto” and “tradfi” worlds were Silvergate, Signature, and SVB.

Recent events have destroyed partnerships, cut fiat on- and off-ramps, and made banking services for cryptoasset enterprises harder than ever. This goes against the idea of supporting alternative finance and is instead a misguided attempt to hold on to a system that is in danger.

It makes less and less sense to cut off the links between traditional finance and cryptosystems on the assumption that the old system is good and safe and the new system is bad and risky.

On both sides, there are risks that are unique to how each side works. Trying to force and control decentralized finance doesn’t work; all it does is push the financial worlds further apart and make it impossible for it to connect with what has come before.

A resilient future financial system embraces innovative financial ideas and structures. It isn’t afraid to use new ideas when they add real value. It welcomes all advances, even if they replace or improve upon previous methods.

The fallout from SVB and Signature Bank shows that financial systems need to be rethought in a much bolder way to make them better, and if recent events are any indication, there are more people than ever who agree with this.