Will USDC enter a death spiral?

USDC price decoupled, Binance, Coinbase and others announced the closure of USDC exchange services. Faced with panic and bank runs, will USDC enter a death spiral?

In just one day, the ripple effect of SVB has reached the crypto market. This morning, due to some deposits in SVB, USDC stablecoin issuer Circle suddenly faced a serious run, and USDC continued to decouple. At the same time, centralized trading platforms such as Binance and Coinbase have announced the closure of some USDC exchange services. As of the time of writing, the price of USDC has decoupled to around $0.933, and more than 2.7 billion USDC have been destroyed in the past 24 hours. Faced with panic and runs, will USDC enter a death spiral?

Why is there a run? $3.3 billion SVB savings

Stablecoin issuer Circle posted on social media today that Silicon Valley Bank is one of Circle's six banking partners and is responsible for managing approximately 25% of USDC's cash reserves with other banks. Circle is currently waiting to see the impact of the Federal Deposit Insurance Corporation's takeover of Silicon Valley Bank on its depositors, but Circle and USDC continue to operate normally.

According to the latest data released on Circle's official website, the current market value of USDC in circulation is approximately $43.4 billion, and the total fund reserves are $43.5 billion, of which $11.1 billion is in cash reserves, accounting for approximately 25%, and the remaining $33.4 billion is in short-term Treasury bond portfolios. At the end of today, it was confirmed that the instructions to remove the balance initiated on Thursday have not been processed, so there are still approximately $3.3 billion of the $4 billion in USD stablecoin (USDC) account reserves remaining in SVB. Like other customers who receive SVB banking services, Circle will follow the guidance provided by state and federal regulators.

What would cause Circle to enter a death spiral?

According to the information currently collected by BlockBeats, Circle should not face much loss in the "SVB incident". However, judging from the current market panic, USDC still faces the risk of continued decoupling. So under what circumstances will USDC experience serious decoupling? BlockBeats has sorted out several key influencing factors.

First of all, the premise of USDC’s collapse must be the continuation of panic. Most of Circle’s backing reserves are U.S. Treasury bonds. If the panic continues, Circle’s cash reserves will be exhausted, which will cause Circle to have to sell its Treasury bonds immediately to meet the market’s redemption demand. Unfortunately, the global interest rate hike has brought the yield of the entire bond market to an unprecedented high. If the Treasury bonds are sold at this time, Circle will face serious losses like SVB, making it unable to effectively respond to market redemptions. At this time, Circle’s redemption cycle becomes longer, which once again promotes panic, intensifies redemptions, and USDC enters a death spiral.

Secondly, at the price anchoring and liquidity level, USDC that cannot be redeemed in time will try to escape through market liquidity. It is undeniable that in terms of on-chain liquidity, USDC is the leader among the current stablecoins, and its shadow can be seen in the LP pools of various AMMs and lending protocols. It should be noted here that because most on-chain lending activities do not use USDC as collateral, the risk of liquidation in terms of price is not high, and the key factor leading to de-anchoring actually lies in the liquidity on the AMM. Now, let's take Curve and Uniswap as the main basis to see how much liquidity is available for USDC to escape.

On Curve, the main outlet for USDC is the 3Crv pool. Currently, the TVL of the pool exceeds $400 million, of which USDC accounts for nearly 50%, worth about $220 million, DAI accounts for about 47%, and USDT accounts for about 3%. If panic continues, the following two situations will occur:

1. Most holders regard DAI as a decentralized shelter and exchange USDC for DAI. At this time, there is temporarily about US$200 million of liquidity on the 3Crv pool to protect the anchor of USDC.

2. Some holders found that most of DAI’s anchoring was backed by USDC, and chose to exchange USDC for USDT. At this time, the weak liquidity of $14 million in the 3Crv pool would cause USDC to continue to de-anchor or even seriously de-anchor.

Another on-chain outflow channel is the AMM pool of USDC against ETH and other assets, such as the USDC/ETH pool of Uniswap V3. Currently, more than 86% of USDC’s 41 billion market value is on the Ethereum mainnet, worth about 35 billion US dollars. Compared with other public chains, the Ethereum mainnet is still the main channel for USDC outflow.

The liquidity pools with the highest TVL on Uniswap V3 are also the 0.01% and 0.05% pools of USDC against DAI, with a TVL of about $400 million, followed by the USDC against ETH liquidity pool. The 0.3% and 0.05% pools have a TVL of about $335 million, of which there are currently about 110,000 ETH in the two pools, worth about $160 million. From the perspective of the entire Ethereum mainnet, the current TVL is 26 billion, and its share of the stablecoin market value is also the smallest among all public chains (excluding Tron).

Therefore, if the market panic continues for a long time, USDC holders will choose AMM as an escape route after the Curve pool is exhausted, and use USDC to exchange various blue-chip or even non-blue-chip assets such as ETH. At this time, on the one hand, USDC may face a price death spiral, and on the other hand, the prices of assets such as ETH may also rise.

What’s worse is that centralized trading platforms have also begun to cut off USDC’s liquidity. This morning, Binance temporarily shut down the automatic conversion of USDC to BUSD, and posted on social media that the large influx of USDC assets has increased the burden of automatic conversion, which is a regular risk management procedure taken by Binance. Subsequently, Coinbase also made the same statement. You know, when CEX big brothers also start to avoid USDC, it may only be a matter of time before other trading platforms do the same. When centralized platforms also cut off liquidity, USDC’s nightmare really came.

What happens if USDC collapses?

Obviously, Circle did not lose much in the SVB incident. The USDC decoupling was a panic or deliberate run, but if Circle really sold its investment portfolio, which was mainly composed of government bonds, it would turn a temporary panic run into a real asset deficit. What Circle needs to do now is to close redemptions, announce external funding support such as financing, and then wait for the market to regain confidence. Of course, as mentioned above, in the process of waiting for confidence to be restored, a serious decoupling of USDC is inevitable.

The biggest concern is not only the USDC depegging problem, but also the run risk of the entire stablecoin ecosystem. Think about it, most of the USDT savings are also government bonds. If Circle eventually sells its government bonds due to the huge depegging pressure and suffers losses, won’t this fire spread to USDT?

The second is decentralized stablecoins such as DAI and FRAX, which are mainly backed by USDC. BlockBeats once pointed out the serious centralization problem of the current stablecoin ecosystem in "Crypto War, the Road to Defending Stablecoins to De-USDC", and the most important factor is the widespread use of the centralized stablecoin USDC. If USDC is seriously depegged, then within one day, the endorsement of stablecoins such as DAI and FRAX will be greatly reduced, and they will also face the risk of bank runs.

The collapse of the stablecoin market means a regression of more than 5 years for the entire crypto industry, because at present, DeFi applications such as AMM, lending, derivatives, and even NFT and NFTfi have long been inseparable from the support of stablecoins, and CeFi is even more so. The collapse of stablecoins means that retail investors have no way to deposit funds, and there is no liquidity in the industry, and the entire crypto ecosystem is in a state of shock.

Of course, the reality is not necessarily so pessimistic. We have found that the price of "old-fashioned stablecoins" such as LQTY is rising. That's right, the algorithmic stablecoin that was once "falsified" by Luna is back. At this moment, stablecoins have become the most decentralized and even the "safest" stablecoin. If this logic is recognized by the market, old stablecoin projects such as Liquity and Tribe will temporarily become a refuge for crypto users.

Of course, these are just pure assumptions, and we still hope that USDC can survive this crisis. What will Circle do next?