Review of the “USDC Crisis”: Why Circle was able to survive

The collapse of Silicon Valley Bank was the largest bank failure since 2008. Bank runs have entered the crypto ecosystem, causing the second largest stablecoin USD C issued by Circle to decouple and fall to a low of $0.85. But just two days later, USDC restored its anchor price and even had a premium . Let's analyze why Circle was able to survive this "USDC crisis".

The story begins with a recent sharp increase in unrealized losses for banks that hold bonds. As interest rates rise, the value of long-term bonds on bank balance sheets is declining, and bonds designated as held to maturity are not being marked down to their fair market value (FMV).

Problems arise for the banks that own these bonds if they are forced to sell them to generate liquidity, causing them to take a loss on their fair market value, which is what happened to Silicon Valley Bank when it tried to withdraw $42 billion on Thursday, March 9th.

Silicon Valley Bank is the 18th largest bank in the United States, with total assets of approximately $209 billion and total deposits of approximately $175 billion. In order to meet the withdrawals of $42 billion, Silicon Valley Bank was forced to begin liquidating its bond portfolio.

SVB was forced to sell its $21 billion available-for-sale bond portfolio, which is now marked down at a discount to what it paid for it, resulting in a $1.8 billion loss, and they are now essentially insolvent having lost all their customer deposits.

Silicon Valley Bank was forced to stop withdrawals and the Federal Deposit Insurance Corporation (FDIC) took over. The FDIC will determine whether the bank will be completely closed or sold in whole or in part to another bank. On Monday, insured depositors will have full access to the $250,000 backed by the FDIC.

Silicon Valley Bank provides banking services to half of all U.S. startups (65,000), but 93% of their deposits are uninsured, which means that these startups may not receive payroll on Monday. One of the organizations holding funds at Silicon Valley Bank is Circle, the issuer of the USDC stablecoin, which has $3.3 billion of its 435 million USD reserves stored at Silicon Valley Bank.

Last Friday, Circle suspended USDC redemptions and both Binance and Coinbase suspended their free USDC stablecoin conversions due to banks being closed over the weekend. Subsequently, USDC’s 1:1 peg with the U.S. dollar broke, and USDC prices plummeted to 85 cents on major exchanges.

USDC’s depegging raises short-term risks as eight of the top 10 DEX liquidity pools use USDC or DAI (48% backed by USDC) as stablecoins.

Subsequently, the decentralized lending market Aave was forced to freeze positions, the lending market Compound was also forced to disable USDC supply transactions, and MakerDAO was also forced to limit its exposure to USDC. Curve's 3pool has run out of USDT, and there is almost no liquidity available for USDC or DAI to exchange USDT. Uniswap's USDT/USDC pool has also been emptied, and more than $70 million of USDT liquidity has been taken out of the pool by traders and LPs.

So, how did Circle survive?

Circle has a profitable business model that actually benefits from rising interest rates by generating income on US Treasuries, and if there is a hole in Circle's balance sheet, they may be able to fill it through revenue generation.

It is important to note that as USDC redemptions increase, the percentage of USDC backing will also decrease. Based on an 80% recovery rate assumption, Circle could potentially fill the $660 million gap in less than six months, and that does not require liquidating its reserve assets.

Circle has assured the market that they will make up any shortfall with company resources and possible external capital while the situation at SVB is corrected, just as all SVB depositors are waiting for a resolution. U.S. Treasury Secretary Janet Yellen also said she is working with regulators to contain the impact and the U.S. government is preparing to take "substantial actions" to support SVB deposits.

Later, the U.S. Treasury, the Federal Reserve, and the FDIC issued a joint statement: "Beginning Monday, March 13, depositors will have access to all of their money. Losses associated with the resolution of Silicon Valley Bank will not be borne by taxpayers."

I think everyone already knows what happened next. The market recovery confirmed Circle’s statement. USDC resumed its anchor price on Monday this week. Circle survived and did not collapse.