A lesson to learn: what does the SVB/USDC turmoil mean for the crypto industry

What’s happened?

First, a brief recap of the events. Silicon Valley Bank, the 16th largest bank in the US, had invested in Treasury bonds whose value decreased as the Federal Reserve raised interest rates. So, when customers started massively withdrawing funds this March, the bank collapsed, marking the second-largest bank failure in United States history (after Lehman Brothers in 2008). Since two smaller banks collapsed right before that and some other banks have similar investment problems, people started questioning the stability of the US banking system in general. 

It shook not only the banking world but the crypto world too. One of the most popular stablecoins, USDC, is pegged to USD and backed by reserves some of which were kept in the SVB. Immediately after the collapse, it was unclear if SVB clients would get their money back, so the situation raised concerns over USDC reliability. That led to USDC temporarily depegging from USD: its price dropped, reaching as low as 87 cents.

Later US government pledged to ensure the availability of SVB clients’ deposits. The situation calmed down, and the USDC price returned to 1 dollar.

But the future is uncertain and things like that can happen again, so naturally, it raises concerns. What should people learn from these events to be as sure in the future as it is reasonably possible?

What are the things to notice?

1. We already knew that stablecoins might turn out to be not-so-stable, with the most notorious case being the collapse of Luna. But this situation is different. The USDC drop was not caused by something within the crypto world: the issue came from the fiat world. The irony of the situation is that for years crypto was called “not as reliable as banks,” but the weak point for a certain cryptocurrency turned out to be a bank.

So, is the lesson for the crypto world to stop dealing with the banks? Some crypto maximalists would say it is: “If we want cryptocurrencies to be great, let’s stop interacting with the fiat world, it brings the very problems we are running away from”. But isolating cryptocurrency would severely limit its usefulness, meaning the approach creates more problems than it solves.

2. Stablecoins are widely used by CEXes and various DeFi services. And that means lots of projects depend on the stablecoins being stable. When the Bitcoin price falls, it just means that some people lose money. However, USDC and USDT becoming volatile would break lots of things. We can see that in the temporary price drop of DAI (another stablecoin): DAI didn’t directly store its reserves in the Silicon Valley Bank, but some of its reserves were in USDC, and when the USDC price fell that created a domino effect.

So, the USDC price drop is a reminder that there’s an existential threat to the whole industry. This time we were lucky and the drop was temporary. We might not be as lucky the next time. We need to understand the risk and minimize it.

3. The uniqueness of the situation is that traditional banking and crypto got a hit simultaneously. When things such as the Luna collapse happen, some people say “crypto is unreliable, use banks”. When something bad happens with banks, people may turn to crypto. But how do you react to a situation where they both prove unreliable? Naturally, this creates confusion for many people, probably best illustrated by this meme:

What takeaways are there for the crypto industry?

So, now that we understood the situation, it’s time to outline “what we should get from that”.

1. Being tied to USD/US does not guarantee stability. The US economy in general, and the USD, in particular, are often perceived as reliable, and there are good reasons for that, so it’s natural that the biggest stablecoins are USD-pegged. But when a big US bank collapses and a USD-pegged cryptocurrency temporarily loses value, it shows there’s no such thing as an absolute guarantee. Even though the USDT price stayed the same while USDC was falling, the reason for that is we don’t even know exactly which banks hold the USDT reserves (so they might also be in trouble).

And there are other reasons to be wary of US-based stablecoins. They are currently regulated on the state level, not the federal one, so future federal regulations might change things in unpredictable ways. And some experts say there’s ongoing “Operation Choke Point 2.0” in the US aimed at “choking” crypto firms. It makes the whole situation less stable.

2. And it’s not only a USD problem. It’s well-known but always worth reminding: nothing is ever perfectly reliable (any bank, cryptocurrency, fiat currency). And what’s more, different things may prove unreliable at once (a large bank and two stablecoins in this case). So being tied to USD doesn’t give guarantees, nor do other things.

So if nothing can be fully trusted, what to do in times of instability? The tried-and-true answer is to double down on diversification.

3. How to diversify when dealing with stablecoins? 

The first option (the most simple one) would be to use a few of the biggest ones, such as USDT and USDC. “Since they are the biggest, they are probably the most reliable, right? I’ll just use more than one of them.”

But while it won’t hurt to do that, it still doesn’t help with the risks tied to USD itself. What would happen if something bad happened to the entire US banking system? What would happen if the US changed the crypto laws drastically on a federal level? 

So to truly diversify, it might be a good idea to lower the reliance on USD. How to do that if the most known stablecoins are USD-pegged and USD-backed? It’s high time to realize they are not the only ones in the market. 

Here comes a second option: there are stablecoins like DAI. It’s also USD-pegged, but it’s a “crypto backed by crypto”. Instead of keeping reserves in the banks, it relies on an intricate system of smart contracts to hold different types of accepted cryptocurrencies in exchange for the issued tokens.

Unfortunately, that system doesn’t make DAI completely immune from the fiat world. As mentioned earlier, its reliance on USDC temporarily dropped the DAI price in the wake of the SVB collapse. But it’s one more step away from fiat than USDC, so it might be useful for diversification.

The third option is using stablecoins pegged to currencies other than USD and based in countries other than the US. A “shameless plug”: VNX created stablecoins tied to Euro and Swiss francs. And being based in Liechtenstein, we deal with thoughtful regulation on the country level. So in the scenario, if something happens with USD or US laws tomorrow, our stablecoins might be more reliable than USD-based ones by US companies.

The fourth option is pegging to things other than currencies. For instance, there are gold-pegged stablecoins (we make one of those too).   

I also think a fifth option will appear later: a stablecoin less tied to the fiat world than the ones popular nowadays. Luna has collapsed, but the algorithmic approach might prove useful in the future, bringing something more robust. Or maybe Bitcoin will eventually become stable by itself. One way or another, I think there’s a need for a new kind of stablecoin in the market, and someone will fill that niche sooner or later.

Summary

If you or your project depend on stablecoins and don’t want events like SVB collapse to ruin everything at once for you, it’s time to think about diversification. There are currently several options for that: USD-based stablecoins (like USDT), crypto-backed ones (like DAI), pegged to currencies other than USD (like VNX Euro), pegged to gold (like VNX Gold). Use a combination of those you deem reasonable for your circumstances.

Also, it also might be a good idea to keep an eye on the stablecoin market so you won’t miss the next great thing to come.

By Michael Epishkin (VNX)

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