USDC market situation
The stablecoin USDc issued by The American Company - Circle received a 15% depeg (a depeg is a situation that occurs where a stablecoin loses it’s parity to a dollar, some might find this as an opportunity for arbitrage while others consider it a risk like UST and exercise risk management) over the weekend 10-13th March 2023, falling to as low as 0.85c to the dollar.
Why did this happen? Let’s dive in
Silicon Valley Bank (SVB) is a commercial bank based in Santa Clara, California, USA. It was founded in 1983 and has been in operations for 40 years. It was a leading provider of financial services to the technology and venture capital industries.
The FDIC seized SVB on Friday following a run on the bank by depositors. It was the second-biggest bank failure in U.S. history and the largest since the financial crisis 15 years ago.
Why does this matter?
It was also one of the banks that held partial reserves USDC is paired to, to the tune of $3 billion dollars. The entire business model of a stablecoin is that it is always redeemable for a dollar on demand, that means for every single stable coin issued, there is a dollar sitting down in a bank, treasury bill, or easily redeemable money market instrument.
What happened next was anyone’s guess, SVB was unable to redeem customer withdrawals due to a lack of liquidity, they had misallocated their capital into long term bonds with interest rates below 2% for 10 years. This is a problem because the federal reserve has been increasing interest rates steadily since last year,this is known as duration mismatch.
I know I promised simplicity so here’s a brief explanation of this
Duration mismatch is a concept in finance that refers to the difference between the maturity or time to payment of a financial institution's assets (such as loans or investments) and liabilities (such as deposits or other sources of funding).
For example, imagine a bank that has a lot of long-term loans (assets) on its balance sheet, but mostly short-term deposits (liabilities) from customers. If interest rates were to increase, the bank's borrowing costs would increase more quickly than the income generated from its loans could catch up, leading to lower profitability. Conversely, if interest rates were to decrease, the bank's cost of borrowing would decrease more quickly than the income generated from its loans, leading to higher profitability.
To avoid these risks, financial institutions use different strategies to try to align the maturities of their assets and liabilities. This helps them manage their risk exposure and maintain stable profitability over time.
So short term money market instruments have a duration less than 1 yr eg Treasury bills currently have an interest rate of 4.5% while the bonds that silvergate holds have lower rates and would have to be sold at a discount in order to fulfil their obligations to their customers.
This effectively led to a bank run with customers scrambling to get their money out of Silicon valley bank before it was too late, Circle being affected by this bank run caused speculation in the crypto markets on their ability to redeem USDC:USD 1:1.
Massive selloffs from users holding USDc scrambling to safety in other stablecoins like USDT & BUSD from the uncertainty in Circle’s finances led to the depeg event. Once LUNA’d, forever wary.
As at today, the USDC peg has been restored due to Federal regulators announcing $175 billion in customer deposits will be backstopped by the federal government.
TL;DR
Circle depegged over the weekend to about 0.85c, because Silicon Valley Bank failed after a bank run.
The peg has been restored because the United States Federal Government has promised to make all customers whole.
Risk management in assigning a stablecoin portfolio should be exercised, either in the form of
Holding a basket of multiple stablecoins eg USDT, LUSD, BUSD
Hedging against a depeg by using platforms like Y2K Finance
Insurance against stablecoin depegs with platform like Nexus mutual
(As always NFA, DYOR)