Stablecoins Deliver on Their Promise: Disrupting Banks

Article author: STEVEN KELLY Article compilation: Block unicorn

Stablecoins may also encounter a banking crisis

USD Coin (USDC), issued by Circle, has long been the “good guy” among stablecoins — second only to the sometimes-troubled Tether in market capitalization. Circle's model is based on investing in cash and short-term Treasuries and provides transparent disclosures. This is also the basic model that Congress has adopted when trying to pass stablecoin legislation, but it is not wise.

This structure has worked very well for Circle for a while. Despite Tether's first-mover advantage and other advantages, Circle is nearly catching up in market capitalization. By the time Terra/Luna collapses in May 2022, Tether's share of the dollar-based stablecoin market has fallen to less than half, while Circle's market share has reached almost 40%.

As Circle wrote in their "Trust and Transparency" blog series last July (with all emphasis added):

“Comparing Circle to those trusts or banks that use a fractional reserve model is like comparing apples to oranges. We will not lend our USDC reserves to anyone , Circle’s USDC is a fully-reserved U.S. dollar digital currency. Unlike banks, exchanges, or unregulated institutions, Circle cannot lend USDC reserves out…”

This is a point that Circle has repeatedly emphasized in the field of public opinion and in Washington, D.C.

As Circle CEO Jeremy Allaire testified before Congress: “A fully-reserved digital currency model, such as USDC, in which 100% of assets are held in high-quality assets such as cash and short-term U.S. Treasuries Fully reserved in the form of liquid assets, which is not the same as bank deposits. Bank deposits are the process by which banks take deposits and re-mortgage and lend.”

Sounds great for stablecoin holders! Customers' money is completely stored in a safe place, and their money is marked with the customer's name, and can be easily withdrawn and used. Risky investment in short-term treasury bonds will not expose customers to the risk of loss of funds.

So, as a non-bank institution, how can such security be achieved? The answer is "cash" (that is, bank deposits) and short-term Treasury bills. These short-term Treasuries include shares in money market funds and Treasury-backed repurchase agreements with banks and other institutions that may hold long-term Treasuries. In addition, transparent disclosure of these assets is also necessary so that the market can generate trust in these assets. (Transparency, disclosure, and third-party verification are key to preventing stablecoin instability, right?)

OK, so let's take a look at what Circle's disclosures will look like in February 2023:

As of the reporting date, Circle's cash was deposited with the following U.S.-regulated financial institutions: Bank of New York, Citizens Trust Mellon Bank, Customer Bank, Commercial Bank of New York, a branch of Flagstar Bank of North Carolina, Signature Bank, Silicon Valley Bank, Silvergate Bank.

Thus, over the course of three days in March, the “full reserve” USDC-backed asset became an enviable portfolio for distressed credit investors. So, too, is USDC itself. Under the weight of the aforementioned disclosure (transparency!), USDC began to fall, and when Circle revealed that $3.3 billion was actually stuck in SVB, USDC’s value dropped even more severely despite attempts to withdraw:

USDC traded below $0.9 that weekend — until the government announced it would support uninsured deposits in bankrupt banks:

The “we don’t lend out reserves” rhetoric has always been absurd, and now USDC has gone through a 48-hour walkthrough that further clarifies it. To truly be "full reserves" is to have all reserves deposited with the central bank.

Otherwise, claiming that something less than full reserve is "full reserve" is extremely misleading. Uninsured dollars in banks (of which USDC probably needs at least some of them, and there are plenty of them anyway) are loans to those banks as they are converted from digital currencies connected to the blockchain system to traditional currencies It is an important bridge connecting the traditional financial system and the digital currency system. Circle is issuing demand liabilities and making venture loans, so it's a bank:

In March, the transparency of its asset book led to the loss of liabilities (the larger the bank user deposits or the volume of USDC, the greater the liabilities, because these funds need to be paid to customers, so they are liabilities), although they did not face any losses in the end , but that suggests it's a bank. And Tether, which is relatively riskier but subtly less transparent, regained a lot of market share in March, so it is also a bank:

So the emerging consensus on how to make "stablecoin payments" stable remains shaky. However, from a financial stability perspective, USDC's falling value is not the most important thing. The big part of the story is when Circle tried to withdraw $3.3 billion from the bank after getting bad news from the bank.

Stable coins, volatile deposits

While $3.3 billion in funding does not change SVB's fortunes in this case, one could easily imagine a situation where the stablecoin, operating on behalf of its holders, would put pressure on systemically important counterparties. If Circle succeeds in taking funds out, it would be great for stablecoin holders, but it could come at the cost of system stability.

Between March 6 and March 31, Circle withdrew approximately $8 billion in USDC-backed deposits from the banking system. From a macro perspective, $8 billion is nothing. But for some particular banks, it could mean everything; someone has to act as a marginal counterparty when the bank is in survival mode.

In line with broader trends in the banking market, Tether moved about $5 billion in deposits out of deposits into repurchase agreement transactions in the first quarter. Even if the funds end up going back to the exact same borrowers, costs will increase and there may be some temporary disruption. More likely, someone lost their source of financing.

But isn’t this the fault of bad borrowers (aka banks) rather than stablecoins fulfilling their fiduciary duties? After all, holders redeemed about 25% of the outstanding USDC stablecoin in March, more than $10 billion! Circle must have liquidity to meet these obligations.

However, the presence of non-bank stablecoins is increasing systemic vulnerabilities by entering intermediary chains. Blockchain data shows that most holders of Tether (USDT) and USDC hold amounts that should generally be insured by the Federal Deposit Insurance Corporation (FDIC):

So if you exclude non-bank stablecoins from intermediary chains (or require them to become banks), you are left with sticky, insured depositors in the banking system.

That is, non-bank stablecoins are effectively aggregating insured deposits and converting them into uninsured deposits and other wholesale financing in order to provide cryptocurrency services to customers. And these financings are at risk of meeting fiduciary obligations at the first sign of trouble. If stablecoins are really “payment stablecoins,” as Congress claims, they should simply be a payment technology and exist under the deposit books of the banking system. Non-bank stablecoins can achieve security for themselves, but at the same time introduce risk to the entire system.