Failing banks, stablecoin woes and the FED to the rescue

The past few days in crypto, but also in Silicon Valley and even the financial industry at large, have been hectic, to say the least. After Silicon Valley Bank (SVB) was unable to meet withdrawals, panic ensued which spread to the crypto market. 

Once it became clear that the company behind the stablecoin USDC, Circle, had a portion of the capital backing the stablecoin stalled at the failed Silicon Valley Bank, investors ran for the exits and USDC de-pegged from the Dollar, leading to high volatility and uncertainty in the market.

In this article, we take a look at what exactly happened over the weekend both within and outside of crypto, and the possible implications for the week ahead. Regardless of how all this will play out, it’s already clear that what’s happening will be one for the history books.

Banking failures

Rising interest rates 

Before we have a look at the bank failures, It is important to note that the cause of these bank runs is not related to the crypto industry, but is part of a much larger, structural issue. It is becoming clear that structural problems have been created by the FED raising interest rates at one of the fastest paces in history, leading to significant second and third-order consequences that the financial system hasn’t been able to adapt to yet.

Back in 2020/2021, there was an endless amount of money flowing into banks, many of whom decided to store these funds in what is known as a low-risk yield product, government bonds.

These banks are now left with long-term (10y, 30y) government bonds bought at a time of historically low interest rates, which as a result of the rapid hiking spree ended up losing a lot of their value and thus creating big (unrealized) losses for these banks.

Silvergate

Crypto-friendly bank Silvergate might’ve been the canary in the coal mine. After the bank experienced a bank run in which parties using the bank were claiming their deposits en masse, it incurred substantial losses and had to close shop. Due to the FTX collapse, Silvergate revealed a fourth-quarter loss of $1 billion. Silvergate’s deposits dropped from $11.9 billion at the end of Q3 to $3.8 billion in Q4. 

To facilitate these large outflows the bank initially used wholesale funding, but then sold debt securities to accommodate lower deposit levels and maintain a liquid balance sheet. While the bank was fully regulated and did its risk management according to the required standards, a mass exodus was not planned for - forcing the bank to sell assets at a loss and leading to its demise.

Silicon Valley Bank

In a similar turn of events, Silicon Valley Bank (SVB), a bank mostly used by the California-based tech and startup industry, was closed by regulators on Friday the 10th after it experienced a bank run and didn’t have enough cash to cover the withdrawals.

The run began on Thursday when a powerful Silicon Valley VC — Peter Thiel’s Founders Fund — began advising its portfolio companies to withdraw their money from SVB.

For Thiel’s Founders Fund, the last straw may have come on Wednesday.

That day, SVB announced that in order to fund the increased withdrawals they would be raising an additional $2 billion in capital from other investors, which sent off the signal that there was something wrong.

The stock fell by 60% in premarket trading Friday before being halted. The shares never reopened for trading Friday.

SVB experienced a staggering $42b in withdrawals on Thursday, which amounts to about $1 million per second. 

USDC and stablecoin woes

One of the companies banking with SVB was Circle, the company behind the stablecoin USDC. On Friday the 10th of February, this information started circulating and rapidly caused a widespread panic. USDC derives its trust and stability from the fact that the crypto-dollar can always be redeemed on a 1:1 basis for traditional dollars. Once this was in question, investors started selling USDC everywhere they could. This caused USDC to de-peg as there were lots of sellers but very few buyers.

At the peak of the fear, the USDC price across exchanges crashed to $0.88. On some illiquid exchanges, prices of $0.5 and even $0.1 have been seen, and one incredibly unlucky panic seller got $0.05 for his roughly $2m in USDC. 

In turn, other stablecoins started losing their peg to the dollar. The reserves of both MakerDAO’s DAI and Frax’s stablecoin include USDC, meaning the value backing their stablecoin went down, leading to concerns about their redeemability. Over the course of these events, panic led to irrationality, and rumors of unbanked or insolvent exchanges and stablecoin issuers led to massive volatility in the stablecoin sector. 

On Saturday morning, Circle stated in a blog post that they were banking with SVB and had $3.3 billion (which is about 8% of their total $41.2b reserves) deposited in the bank. They stated that they were positive that they would still get their $3.3b back through the FDIC and reassured that they were also in a position to cover the hole themselves in the worst-case scenario.

This caused the USDC price to crawl back towards its 1:1 peg, although it took the confirmation below that all redemptions would be honored on Monday to cement itself back at $1.

Much bigger than crypto

While Silvergate was a crypto-bank, SVB mostly banked non-crypto companies. By some estimates, about 65,000 Silicon Valley-based startups were banked with SVB among many other companies outside of the startup and tech industry. It even became clear that after withdrawals were halted, about 200 UK-based startups couldn’t access their capital either. 

Panic across the US start-up sector broke out on Friday as it became clear that many startups couldn’t access their capital on SVB, meaning that they couldn’t pay their employees, suppliers and service providers. 

As has happened throughout history, panic and bank runs spread at the speed of sound and over the weekend, another larger (and also crypto-friendly) bank, Signature Bank, was closed on Sunday by the state authority. 

Now, it’s anyone’s guess what the further fallout will be. Whether rational or not, it is likely that people want to make absolutely sure that they won’t lose their money and start withdrawing their capital from any bank that is suspect of being insolvent. In the fog of chaos and the era of the internet and misinformation, almost any bank can become subject to this. Below is the market’s first response on Monday.

In the words of a derivatives exchange founder and popular market analyst Arthur Hayes: “the entire US banking sector has an asset / liability mismatch, and it's 100% due to easy then tight monetary policy.” He also believes this will lead to capital injections and reduction of the interest rates or in his words:

The FED to the rescue? 

The above-described potential catastrophe quickly became clear to the US financial regulators, who decided to step in over the weekend. In a joint statement, they assured that SVB and Signature clients would get all their money back by Monday 13th. 

The Federal Reserve, Treasury and FDIC also announced a new bailout package that includes the Bank Term Funding Program (BTFP). 

The BTFP is designed to provide loans to eligible depository institutions using US Treasuries agency debt, mortgage-backed securities, and other qualifying assets as collateral. The program is backed by a commitment of up to $25 Billion from the Department of the Treasury and is intended to provide liquidity to banks and other financial institutions. The BTFP will help protect people's money held in the affected banks. The FDIC insures deposits, and the BTFP will ensure that the FDIC has the necessary resources to cover any losses. 

These actions might become essential over the coming period as SVB and Signature’s problems don’t seem to be isolated, but structural problems present across the financial system.

A big week ahead

Sometimes there are decades where nothing happens, and sometimes there are weeks in which decades happen. The past week and coming weeks might turn out to be the latter as the US, their FED and even possibly the global financial sector could get severely stress-tested. There are possible changes to the interest rates, monetary policies, and banking and financial regulations and dynamics. 

For now, the USDC stablecoin seems to be safe as it will most likely be fully backed again and relative stability has returned to the stablecoin sector. However, Silvergate, SVB, and Signature were the largest crypto-friendly banks and the US-based crypto industry has effectively lost its main access to the traditional banking industry. This will have big implications, and the effects will become clearer over the next weeks. 

With the FED’s announcement that depositors at the insolvent banks will get their money bank, stability might return to the startup sector and market at large as well, but that remains to be seen. As Roosevelt once said, “the only thing we have to fear is fear itself” and the coming week will show how fearful the market really is. Buckle up.