The collapse of the Silicon Valley Bank has left many financial casualties.
Tech companies are currently struggling with their payrolls, while the value of bank stocks has been on the decline for more trusted financial instruments like bonds. There is also a growing loss of faith in the US economy, which could have far-reaching effects that are difficult to grasp at present.
The collapse of stablecoins is another casualty left in the wake of the SVB fiasco. USDC and Dai traded below $1 pegs as news of SVB filtered through social media.
Since stablecoins are intended to mimic the dollar, the recent string of declines in value has raised doubts about the stability of stablecoins.
What are the implications for investors?
With $212bn in total assets, Silicon Valley Bank (SVB) was the 6th-largest bank in the United States, serving roughly half of all venture-backed US technology and life sciences companies. The bank's revenue came from:
In 2021, at the height of the tech investment growth, customer deposits increased from $102bn to $189bn, leaving the bank with "excess liquidity." SVB ended the first quarter of 2020 with total deposits of just over $60 billion. By the end of the first quarter of 2022, this had skyrocketed to nearly $200 billion.
However, the Silicon Valley based financial institution incurred an unrealized loss of $15bn. This figure almost equals the bank's $17 billion market capitalization and is greater than the bank's total profits over the past three decades.
SVB invested billions of dollars in longer-term U.S. Treasuries and government-backed mortgage securities.
SVB's portfolio of securities increased from approximately $27 billion in the first quarter of 2020 to approximately $128 billion by the end of 2021.
Due to the increase in market interest rates due to Fed rate hikes, the value of treasuries are abruptly declined, which meant the bank was at a loss. Simultaneously, deposits into the bank also decreased as cash public offerings virtually dried up with new IPOs hitting the market.
Cash from fundraising also ceased, as borrowing costs increased along with the Fed's rate increases.
As such, it became much more costly for SVB to attract new deposits, as savers demanded higher interest rates. The number of deposits in the bank dropped from nearly $200 billion at the end of March 2022 to $173 billion by the end of the year.
SVB attempted to solve its dilemma by selling a significant portion of its securities, valued at $21 billion at the time of sale, at a loss of approximately $1.8 billion after taxes. The bank's objective reset its interest earnings to today's higher yields.
This would have provided it with the balance-sheet flexibility to accommodate prospective outflows.
Following this announcement, the bank's situation appeared to worsen. The announcement of the share sale caused the stock price to plummet, making it more difficult to raise capital and causing the bank to abandon its share sale plans.
The price of USDC fell below $1 to $0.87 as news of SVB's collapse broke the internet.
Another stablecoin, Dai, also decoupled from its $1 value on Saturday, trading as low as $0.90. In contrast, some investors exchanged their USDC and Dai coins for Tether and other stablecoins. Strong demand caused Tether to trade marginally above its $1 peg.
The devaluation of USDC and Dai is an addition to the list of stablecoins that have lost value over the past few years. In 2022, as a result of a general decline in the crypto-asset markets, TerraUSD plummeted to a price below $0.10.
Concurrently, its market capitalization dropped from approximately €18 billion to less than €2 billion.
This resulted in a sell-off that drove its sibling token Luna to zero as well. The collapse of the two cryptocurrencies wiped out $40 billion in market capitalization and sparked a succession of crypto market crashes in 2022.
Tether was also under duress as the largest stablecoin depegged from the dollar. The decline resulted in more $8 billion in outflows or nearly 10% of its market capitalization.
Stablecoins can depeg due to a number of reasons.
Shifts in economic conditions can cause a stablecoin to depeg, such as:
A stablecoin could depeg due to regulatory changes on cryptocurrencies.
For example, if a government were to ban the use of stablecoins, demand would drop, causing its value to fall.
Given that crypto investors are drawn to the asset due to its decentralized system, a regulation would definitely defeat this purpose as it would entail government oversight and control. This would weaken investor sentiment and demand for cryptocurrencies.
Technical issues like smart contract bugs, security breaches from hacks or network congestion can cause a stablecoin to fall below its $1 peg.
For instance, a smart contract flaw could result in the stablecoin’s value being computed improperly, causing a sizable departure from its peg.
Stablecoins have become an increasingly vital component of the digital asset ecosystem, with a market capitalization of over $130 billion.
They are utilized by crypto traders to rapidly enter or exit positions in more volatile cryptocurrencies, while corporations frequently safeguard their capital and profits in stablecoins.
Breaking USD Coin's dollar anchor has the potential to send shock waves throughout the cryptocurrency community, which is still suffering from the demise of FTX.
A stablecoin is susceptible to a run, similar to a bank If holders are concerned that they may not receive their $1 back, they will sell their coins at a discount to $1.
However, many investors found themselves unable to convert their USDC to fiat.
Crypto exchange Coinbase paused conversions between USD Coin and the U.S. dollar, citing heightened activity. The world’s largest crypto exchange Binance temporarily suspended its auto conversion from USD Coin to Binance USD.
This no doubt has raised the issue of trust. Most crypto investors saw cryptocurrencies as a viable alternative because they wanted to escape the gatekeeping that was in traditional finance. They are being proved wrong time and time again.
An obvious lesson that can be drawn from the seeming instability of stablecoins is no asset is risk-free or foolproof.
We have seen this trend in the plummet of stock prices, companies going bankrupt, the continual devaluation of the dollar of the mortgage crises of 2008.
While some investments may be touted as safe, the onus lies on the investor to treat every investment with skepticism.
Continually asking yourself, "what if?" ensures that you implement the appropriate risk management strategies and diversify your assets.
The inability of USDC holders to convert their stablecoins due to the freeze by crypto exchanges once again highlights the lack of transparency in the crypto world.
This lack of transparency was a pattern evident in the collapse of FTX and Terra. Terra Lab’s founder Do Kwon even used a pseudonymous name to launch another algorithmic stablecoin, Basis Cash.
Investing in regulated protects the financial future of individual investors.
It also protects the stability of the ecosystem and engenders trust among investors. The aftermath of a brutal market selloff and the collapse of the FTX crypto exchange last year only reinforces the importance of investing in regulated assets.
SVB's misfortune and the resultant fall in stablecoins prove that several professional investors don't have much helpful information about what is safe.
None of the so-called financial experts, or even regulators spotted SVB's overexposure and the impact of falling bond yields on its capital reserves. Also, none highlighted the potential danger this may have for cryptocurrencies.
The reliability of an investment is based on its market value. While the majority is going where the money is, that doesn't mean you should do the same. Remember, using due diligence is crucial.
A hard pill for crypto investors to follow is that the fate of cryptocurrency is still tied to traditional finance.
Prices of cryptocurrencies such as Bitcoin and Ethereum have been mimicking the trends of Nasdaq.
Cryptocurrencies which were largely thought of as hedge to inflation have largely failed in that regard as the price of assets have plummeted by as much as 60% (and even more) since 2021. The increase in Fed rate hike has plummeted the price of cryptocurrencies as investors have sought safer investments.
Big financial institutions are also among the biggest players in cryptocurrencies. These 'whales' with their large outsized funds determine price shifts in the market thereby determining the price.
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