Author: 3HOUSE user @liqu1d

The USD stablecoin (USDC) is a cryptocurrency pegged to the US dollar, issued by the American fintech company Circle. Since its launch in 2018, the market size of USDC has expanded rapidly, becoming the world's second-largest stablecoin. Although the market has high confidence in USDC, a series of recent events have revealed its potential risks.

On March 8th, the well-known crypto-friendly Silvergate Bank announced its liquidation, returning all deposits to its customers. On March 10th, Silicon Valley Bank, which specializes in providing financial services to tech companies in Silicon Valley, sold $21 billion in sellable securities, suffering an $18 billion loss due to liquidity issues. Its stock price plummeted more than 60% on Thursday, evaporating $94 billion in market value in a single day. So, why did Silvergate and Silicon Valley Bank face financial collapse?

First, we need to understand the business model of the banking industry. Simply put, commercial banks are companies that deal with money, and their business models are no different from other businesses – buy low, sell high, with money being the product.

After the outbreak of the COVID-19 pandemic, the Federal Reserve started pumping money into the economy, lowering interest rates to zero, and lending funds at almost no cost. The market became flooded with large amounts of money, with numerous start-ups and enterprises receiving massive financing. Silicon Valley Bank, which serves innovative companies in Silicon Valley, had many venture capital firms and tech companies as clients, including USDC issuer Circle and A16z.

Due to the influx of money, Silicon Valley Bank's savings grew significantly. However, as the internet boom peaked and opportunities for returns decreased, the bank purchased large amounts of long-term US Treasury bonds before interest rates rose. As interest rates increased, the value of these bonds fell, causing paper losses for Silicon Valley Bank. Simultaneously, many depositors increased their withdrawals from the bank due to rising interest rates. At this point, Silicon Valley Bank's liquidity reserves were insufficient to meet the withdrawal demands of its customers, forcing the bank to sell some securities at an actual loss and seek external financing. This action led to the subsequent collapse of the bank, as customers and major institutions began withdrawing funds from Silicon Valley Bank after learning of its liquidity crisis. The market became fearful, with numerous withdrawals leading to a bank run.

Returning to Silvergate and Silicon Valley Bank, we find that the fundamental cause of their crises is the mismatch of their investment terms. At the root of this problem is the Fed's interest rate hikes, which led both banks to make erroneous investment decisions. In the end, they both became casualties of the dollar cycle.

In this event, USDC faced a crisis due to Circle holding $3.3 billion in reserves in Silicon Valley Bank, which collapsed, potentially causing losses to these reserves. As USDC is a fully regulated stablecoin issuer, the risk was transmitted to USDC when its reserves were affected by the bank's collapse, causing USDC's price to temporarily drop below $0.9.

With Circle and Coinbase suspending USDC to USD conversions, the only way to cash out was through the eight USDC-USD trading pairs on decentralized exchanges (DEX). These pairs had relatively low liquidity: in the first week of March, daily trading volume was only between $20-40 million. However, after the crisis, trading volume reached a historical high of $600 million, with Kraken being the main provider of liquidity. The order book could not handle the large sell orders, causing USDC's exchange rate to plummet. Before USDC lost its peg, the USDC-USD order book had less than $20 million in bids, insufficient for the billions in sell orders. Binance eventually relisted the USDC-USDT trading pair, but by then, USDC was trading at a significant discount on less liquid centralized exchanges (CEX). Shortly after, the trading volume of the USDC-USDT pair reached $9.9 billion, setting a new record as traders sold or bought USDC at unpegged prices. On March 13th, Circle CEO Jeremy Allaire announced that USDC's reserves were 100% secure, and institutions like the Federal Reserve said that customers could withdraw all cash from Silicon Valley Bank, calming market panic. The USDC crisis gradually subsided.

1. Direct cause: Reserve asset issues, specifically the placement of cash reserves in Silicon Valley Bank, which collapsed, putting some deposits in danger and causing a bank run. Additionally, although USDC claimed to have sufficient USD assets as reserves, these assets could face devaluation risks during US financial market turbulence. If asset devaluation causes reserve shortages, USDC's stability would be severely impacted.

2. Root cause: The Federal Reserve's interest rate hike led to a dollar shortage in the market, causing liquidity issues and increasing demand for withdrawals. The rate hike caused bond prices to fall, creating bank losses due to duration mismatch.

1. Impact on the crypto market: The USDC crisis could negatively affect the entire cryptocurrency market, leading to a decline in market confidence and investor withdrawals. Moreover, due to USDC's widespread use in the decentralized finance (DeFi) sector, its crisis could impact the entire DeFi ecosystem, triggering a chain reaction.

2. Stricter regulation: As the stablecoin market continues to grow, regulatory agencies' attention and supervision of such cryptocurrencies may intensify. This could result in stablecoin issuers facing more stringent regulatory requirements, affecting market development.

3. Market structure adjustment: The USDC crisis could lead to a market structure shift, allowing other stablecoins to gain more market share. This may prompt market participants to reevaluate the pros and cons of various stablecoins, driving market innovation and development.

4. With the closure of Silvergate and Signature, the crypto market's infrastructure has regressed, as the relationship between the crypto industry and traditional banking systems has become more severed. Real-time payment networks like Silvergate Exchange Network (SEN) and SigNet are crucial for managing overnight and weekend liquidity, promoting OTC trading, arbitrage between exchanges, and stablecoin redemptions outside regular opening hours. As these solutions disappear with no immediate alternatives, fiat deposits may worsen, increasing the likelihood of price volatility.

The crisis involving the US dollar-pegged stablecoin USDC has exposed potential risks within the stablecoin domain, attracting widespread attention from the market. In order to ensure the healthy development of the stablecoin market, regulatory authorities and market participants need to closely monitor events like this and take appropriate measures to mitigate risks. Additionally, market participants should enhance their understanding of stablecoins, make prudent investment choices, and avoid incurring losses due to market turbulence. Only by fully recognizing the risks associated with stablecoins and taking necessary measures can the stablecoin market achieve sustainable development.

About Campfire

Campfire is the 3HOUSE community's fortnightly focus direction. Every two weeks, the development team, in collaboration with the community, look at an important and relevant issue within the crypto industry and try to unpack it from multiple angles.

Campfire is our community's way of getting to the heart of complex issues together to better inform investment decisions and cut through the noise of traditional content platforms.

Author: 3HOUSE user @liqu1d

The USD stablecoin (USDC) is a cryptocurrency pegged to the US dollar, issued by the American fintech company Circle. Since its launch in 2018, the market size of USDC has expanded rapidly, becoming the world's second-largest stablecoin. Although the market has high confidence in USDC, a series of recent events have revealed its potential risks.

On March 8th, the well-known crypto-friendly Silvergate Bank announced its liquidation, returning all deposits to its customers. On March 10th, Silicon Valley Bank, which specializes in providing financial services to tech companies in Silicon Valley, sold $21 billion in sellable securities, suffering an $18 billion loss due to liquidity issues. Its stock price plummeted more than 60% on Thursday, evaporating $94 billion in market value in a single day. So, why did Silvergate and Silicon Valley Bank face financial collapse?

First, we need to understand the business model of the banking industry. Simply put, commercial banks are companies that deal with money, and their business models are no different from other businesses – buy low, sell high, with money being the product.

After the outbreak of the COVID-19 pandemic, the Federal Reserve started pumping money into the economy, lowering interest rates to zero, and lending funds at almost no cost. The market became flooded with large amounts of money, with numerous start-ups and enterprises receiving massive financing. Silicon Valley Bank, which serves innovative companies in Silicon Valley, had many venture capital firms and tech companies as clients, including USDC issuer Circle and A16z.

Due to the influx of money, Silicon Valley Bank's savings grew significantly. However, as the internet boom peaked and opportunities for returns decreased, the bank purchased large amounts of long-term US Treasury bonds before interest rates rose. As interest rates increased, the value of these bonds fell, causing paper losses for Silicon Valley Bank. Simultaneously, many depositors increased their withdrawals from the bank due to rising interest rates. At this point, Silicon Valley Bank's liquidity reserves were insufficient to meet the withdrawal demands of its customers, forcing the bank to sell some securities at an actual loss and seek external financing. This action led to the subsequent collapse of the bank, as customers and major institutions began withdrawing funds from Silicon Valley Bank after learning of its liquidity crisis. The market became fearful, with numerous withdrawals leading to a bank run.

Returning to Silvergate and Silicon Valley Bank, we find that the fundamental cause of their crises is the mismatch of their investment terms. At the root of this problem is the Fed's interest rate hikes, which led both banks to make erroneous investment decisions. In the end, they both became casualties of the dollar cycle.

In this event, USDC faced a crisis due to Circle holding $3.3 billion in reserves in Silicon Valley Bank, which collapsed, potentially causing losses to these reserves. As USDC is a fully regulated stablecoin issuer, the risk was transmitted to USDC when its reserves were affected by the bank's collapse, causing USDC's price to temporarily drop below $0.9.

With Circle and Coinbase suspending USDC to USD conversions, the only way to cash out was through the eight USDC-USD trading pairs on decentralized exchanges (DEX). These pairs had relatively low liquidity: in the first week of March, daily trading volume was only between $20-40 million. However, after the crisis, trading volume reached a historical high of $600 million, with Kraken being the main provider of liquidity. The order book could not handle the large sell orders, causing USDC's exchange rate to plummet. Before USDC lost its peg, the USDC-USD order book had less than $20 million in bids, insufficient for the billions in sell orders. Binance eventually relisted the USDC-USDT trading pair, but by then, USDC was trading at a significant discount on less liquid centralized exchanges (CEX). Shortly after, the trading volume of the USDC-USDT pair reached $9.9 billion, setting a new record as traders sold or bought USDC at unpegged prices. On March 13th, Circle CEO Jeremy Allaire announced that USDC's reserves were 100% secure, and institutions like the Federal Reserve said that customers could withdraw all cash from Silicon Valley Bank, calming market panic. The USDC crisis gradually subsided.

1. Direct cause: Reserve asset issues, specifically the placement of cash reserves in Silicon Valley Bank, which collapsed, putting some deposits in danger and causing a bank run. Additionally, although USDC claimed to have sufficient USD assets as reserves, these assets could face devaluation risks during US financial market turbulence. If asset devaluation causes reserve shortages, USDC's stability would be severely impacted.

2. Root cause: The Federal Reserve's interest rate hike led to a dollar shortage in the market, causing liquidity issues and increasing demand for withdrawals. The rate hike caused bond prices to fall, creating bank losses due to duration mismatch.

1. Impact on the crypto market: The USDC crisis could negatively affect the entire cryptocurrency market, leading to a decline in market confidence and investor withdrawals. Moreover, due to USDC's widespread use in the decentralized finance (DeFi) sector, its crisis could impact the entire DeFi ecosystem, triggering a chain reaction.

2. Stricter regulation: As the stablecoin market continues to grow, regulatory agencies' attention and supervision of such cryptocurrencies may intensify. This could result in stablecoin issuers facing more stringent regulatory requirements, affecting market development.

3. Market structure adjustment: The USDC crisis could lead to a market structure shift, allowing other stablecoins to gain more market share. This may prompt market participants to reevaluate the pros and cons of various stablecoins, driving market innovation and development.

4. With the closure of Silvergate and Signature, the crypto market's infrastructure has regressed, as the relationship between the crypto industry and traditional banking systems has become more severed. Real-time payment networks like Silvergate Exchange Network (SEN) and SigNet are crucial for managing overnight and weekend liquidity, promoting OTC trading, arbitrage between exchanges, and stablecoin redemptions outside regular opening hours. As these solutions disappear with no immediate alternatives, fiat deposits may worsen, increasing the likelihood of price volatility.

The crisis involving the US dollar-pegged stablecoin USDC has exposed potential risks within the stablecoin domain, attracting widespread attention from the market. In order to ensure the healthy development of the stablecoin market, regulatory authorities and market participants need to closely monitor events like this and take appropriate measures to mitigate risks. Additionally, market participants should enhance their understanding of stablecoins, make prudent investment choices, and avoid incurring losses due to market turbulence. Only by fully recognizing the risks associated with stablecoins and taking necessary measures can the stablecoin market achieve sustainable development.

About Campfire

Campfire is the 3HOUSE community's fortnightly focus direction. Every two weeks, the development team, in collaboration with the community, look at an important and relevant issue within the crypto industry and try to unpack it from multiple angles.

Campfire is our community's way of getting to the heart of complex issues together to better inform investment decisions and cut through the noise of traditional content platforms.