The Collapse of Silicon Valley Bank and USDC Depegging — Implications for the Payment Industry
Written by: Stanislav Madorski
This is an opinion piece. The opinions shared within are expressly those of the author and do not constitute financial advice.
Summary: The article discusses the recent depegging of USDC from its underlying asset and the collapse of Silicon Valley Bank (SVB), and their implications for the payment industry. The author suggests that the catalyst for USDC depegging was likely the collapse of SVB, which triggered a banking run and resulted in insufficient funds to cover the withdrawal requests. This caused a panic in the virtual asset market, with investors selling USDC and offramping into fiat or USDT. However, Circle, the issuer of USDC, managed to restore the peg within 24–48 hours. The author argues that this short blip is quite inconsequential when compared to fiat depegs. The optics of the SVB collapse caused by the banking run created a climate of fear within the USA, and the government quickly stepped in to protect funds for many classes of investors and depositors, while a private company took the opportunity to buy over the company, intending to make most customers whole. The article suggests that WadzPay’s operating model hedges many of the risks inherent in the traditional payment industry, making it more resilient to such events.
A Turbulent Weekend
It was a day like any other. On March 11, I woke to a sea of virtual asset red. Most concerning was one red blip in particular: Circle’s stablecoin, USDC, possibly the most scrutinised stablecoin product in the market. The currency, backed by fiat assets, has been available in a tight spread close to its USD peg equivalent for its 4.5-year history, was trading at approximately 90c. The trusted asset had ‘depegged’ from its underlying asset — a term used to describe a deviation from the prescribed exchange rate, usually caused by market or fiscal policy choices; one that is not new in the fiat world. The opposite of a pegged currency is a floating currency — the value of which is fully determined by supply and demand.
The market sentiment was sour — naysayers speculated that virtual assets were on the brink of collapse; media commentators were quick to push out headlines announcing the end of USDC, as well as the virtual asset market.
So, what caused the USDC depegging and the temporarily sour turn in the market? The catalyst was likely a bank — Silicon Valley Bank, or SVB. SVB is a bank headquartered in Santa Clara, California; it was a bank opened targeting the booming tech startup industry in the forward-thinking city. As the bank expanded, it served the majority of American startups by 2015, while also further expanding its footprint to serve the virtual asset market together with its partners and subsidiaries.
Bank collapses are certainly not new — history reveals countless examples of such collapses, which impacts both retail and corporate customers. Those of us with a few additional proverbial concentric growth rings in our stumps are still likely to have images burned into our hippocampus of snaking queues outside banks when banks spiralled into collapse and depositors fear that their funds could be lost.
These collapses may be catalysed by numerous events, but the most definite is likely a banking run. A banking run occurs when large numbers of depositors (those who hold assets in the bank) choose to withdraw their money from the financial institution. These runs have occurred around the world including in Spain, Portugal, Cuba and Argentina.
The reason that these runs typically translate into disastrous impact for the banks requires an understanding of how deposits are managed by many banks. Now, I need to disclaim that I have never worked in the banking industry and that my knowledge of the inner workings of banks is simply as a hobbyist and speculator as opposed to an insider. However, an important assumption explaining the impact of these banking runs is that banks will typically not maintain all deposits in liquid form. A theoretical scenario could be one where a customer deposits $1 million, but the bank will use part of these funds to re-purpose the liquidity in various financial products/investments so that the bank is generating revenue-appreciating activities on these funds. Part of these proceeds go back to the customer (for example, when paying out interest), while also financing the expansion of the bank and improvement to its services.
In the specific case of SVB, the run was caused by a confluence of factors, including a concentration of investments in long-term bonds that had not yet matured, billions in unrealised losses for other investments, and the souring downturn in interest for various tech subsectors. It was discovered that 85% of deposits were uninsured. To simplify a complex situation, an unusual number of investors and depositors called on the withdrawal of their funds within a short period of time, resulting in SVB with insufficient funds to cover the withdrawal requests.
The market was sent into panic. Many virtual asset issuers were queried by investors, probing into exposure to SVB. The demands of the virtual asset crowd lacked patience as companies including Circle would have required further investigation and a vetted community response which takes rounds of legal and financial review; many were unwilling to wait for the response and thus started a cycle of panic selling, as these investors sold USDC for USDT or offramped into fiat. This created a run on USDC, and the supply and demand of the currency temporarily caused the peg to destabilise by approximately 10%.
Circle sprang into overdrive, tightened its communication, committed that the company carries sufficient assets to maintain the peg and restored it back to parity with USD within 24–48 hours. This short blip is quite inconsequential when looked at historically, especially when looking at fiat depegs, such as those in Kazakhstan and Lebanon which had the impact of decimating the permanent relative value of the currencies. Overlooking the market panic, a private company demonstrated its ability to manage ‘fiscal policy’ better than some Central Banks have been able to historically.
The optics of the SVB collapse caused by the banking run created a climate of fear within the USA. If the run triggered a domino effect affecting the sentiment of depositors in other banks, the national impact could cause a shutdown of many other banking institutions. The government quickly stepped in to reinforce that funds would be protected for many classes of investors and depositors, while a private company took the opportunity to buy over the company, intending to make most customers whole.
While bank bailouts are not new (we can look at the Global Financial Crisis for the most vivid example of bailouts in action), this was the first time that a virtual asset focused bank was given the same level of financial support as the traditional banking system.
Implications on the Payment Industry
This short but turbulent period reaffirmed to me that WadzPay’s operating model hedges many of the risks inherent within the industry while reinforcing the importance for the safety and security of customer funds.
Below outlines some principles for the WadzPay 2.0 ecosystem that are vital for a safe payment product:
· Insured reputable custody for virtual assets: custodial service providers hold virtual assets on behalf of their customers. With 1.0, our product was already integrated with BitGo, one of the leading custodials in the world, with insurance benefits for deposits. This mitigates risks such as exchange collapses (a risk which was highlighted by the FTX collapse), and gives customers the confidence that their funds would be available at all times. 2.0 expands custodial offerings further, and provides our customers with optionality for optimal custodial solutions based on geography, pricing and feature sets.
· Support for multiple stablecoins: convertibility between volatile virtual assets, stablecoins and fiat is key to manage exchange rate risk. With customisable algorithms allowing for the conversion of assets based on set criteria (including value and time), the risk of significant market movements is reduced. We design solutions ensuring that the fiat-equivalent amount paid by consumers matches the value that our customers receive at settlement.
· Develop closer relationships with stablecoin issuers: our bet is that stablecoins will become the most utilised virtual asset class for both payments and settlement. Virtual assets provide an unparalleled opportunity to work directly with issuers, something nearly impossible when it comes to fiat currencies for private enterprise.
· Exposure to multiple stablecoin pairs for tokens: protect against future risk of stablecoin depegs (while the risk might be low for the leading currencies, risk avoidance strategies are vital in a developing market). We are looking at launching a USDC pair, on top of USDT pairs for products we are offering, as well as for those designed for customers.
Our forward thinking and risk averse approach to payments, protected our company from a previous collapse of a leading exchange and helped us weather the storm of the aforementioned SVB collapse and temporary USDC depeg. While the virtual asset market is typically transparent, the market has not yet reached the maturity phase; regulations are quite fluid globally and are only starting to be set in stone. Treating customer funds like they are your own and programming in adequate safeguards for those funds is the minimum that blockchain-based payment companies need to do, to ensure safe and complete payment solutions for this exciting market.